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What are Life Insurance Dividends?

Life insurance dividends are a valuable life insurance policy component for those who buy life insurance coverage as a financial vehicle. Dividend-paying whole life insurance policies offer death and living benefits, and when the insurance company performs well, it provides dividends from the company's surplus. Insurers give policyholders several options to apply the funds or receive a cash payout.

Key takeaways:

What are dividends in life insurance?

Dividends are funds returned to a life insurance policyholder from the insurance company's surplus funds. Surplus funds are an excess after the insurer accounts for their expenses and liabilities. When a policyholder pays premiums on a whole life insurance dividend-paying policy, a portion of the payment is invested. When investments perform well, the insurer can pay the policyholder from the excess funds. This is called a dividend payment. Life insurance dividends are only payable to participating policies that share in the insurance company's divisible surplus.

Life insurance is a financial tool with numerous functions. Its most popular function is paying the policy's beneficiaries a death benefit. Term and permanent (whole) life insurance perform similarly in this capacity.

Term life insurance policies last for the length of the term. If the policyholder is alive at the end of the term, they must renew the policy to continue the coverage. Term life policies are traditionally less expensive than whole life policies because they do not have savings and investment features. Therefore, they do not pay dividends.

Whole life is permanent insurance that provides a death benefit and grows cash value that may be used as a living benefit. Cash value develops on a portion of the policy's premiums invested in assets like securities and stocks. When an insurance company performs well and has a surplus of funds, after accounting for death benefit payments, capital, reserves, and expenses, it issues the excess funds to policyholders as dividends.

As long as the dividends paid from a life insurance policy are not more than the total premiums paid by the policyholder, they are considered returns of premiums and are not taxable. Although participating policies offer dividends, they are not guaranteed.

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How is a life insurance dividend calculated?

Life insurance dividends are paid from the insurer's profits available for distribution, called the divisible surplus. The divisible surplus is the premiums paid that exceed the insurer's mortality and expenses.

Life insurance premiums are calculated based on mortality, expenses, and interest. The mortality or the insured's risk of death is, at its base, drawn from mortality statistics compiled by the National Association of Insurance Commissioners (NAIC). People in their 50s usually pay higher premiums than those in their 20s because mortality increases as you age.

Expenses are included in life insurance premium calculations. Expenses are the costs insurers must pay to be in business. Insurers must cover operating costs, maintain reserves, and earn a profit. When insurance companies' investments perform well, they can charge lower premiums.

Fundamentally, life insurance policy dividends are the return of unearned premiums. They are calculated by the number of benefit payouts the company issued and their expenses to determine the surplus amount. Life insurance policyholders decide when signing the contract how they want to utilize dividends based on the options available with the insurer.

What are the most common uses of dividends

Dividend-paying whole life insurance policies are similar to other types in that they are financial vehicles that allow policyholders to use interest earned on premiums as living benefits. Non-dividend paying whole life insurance policies allow for cash-value loans and withdrawals; however, the benefit amount may be reduced by the amount of the loan or withdrawal.

All of the following are dividend options, except unlike loans or withdraws the benefit amount of the policy is not affected.

  • The policyholder may choose to receive the dividends in cash. The insurer will send the dividend amount on the policy's anniversary date.
  • Apply to premiums to reduce the cost, the insurer will apply the dividend to the annual cost of the policy to reduce the premium.
  • Leave the dividends to accumulate interest; the insurer keeps the dividend in an interest-bearing account; the policyholder can withdraw the dividend plus interest at their leisure. Although dividends are not taxable, the interest gained is considered taxable income the year it is credited.
  • Buy paid-up additions; this option increases the policy's total value. The dividend is applied to buy additional paid-up whole-life insurance. Paid-up additions are additional insurance policies eligible for dividends and accumulated cash value. The amount the dividend may purchase depends on your age at the time.
  • Paid-up insurance, similar to a reduced paid-up insurance nonforfeiture option, allows the policyholder to use the dividends to pay off the insurance early to stop paying premiums.

Dividends allow life insurance policyholders to participate in the success of their life insurance company. When the insurer performs well, the policyholder earns a dividend on their premiums that they may use according to the insurer's dividend options, which they may choose and change at will.


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