The only kind of insurance which pays out dividends is whole life insurance. Not all whole-life policies payout dividends either, so make sure you chat to your broker and check the policy’s fine print.
Let’s take a closer look and unpack what dividend-paying life insurance policies are, how they work, and whether they may be suitable for you.
What is a life insurance dividend?
A dividend is the return of a portion of the premiums paid on your policy back to you at the end of the year when it comes to life insurance.
A dividend payment is not necessarily guaranteed as this varies policy by policy. Therefore, it is essential to read the policy carefully.
The amount is not guaranteed either. The amount depends on profits made by the insurance company, investment performance, new policies sold, and the amount of money paid into the policy.
Dividends can be distributed as cash to the policyholder and decrease premiums or buy additional paid-up insurance.
Often, insurance policies that provide a guaranteed annual dividend are more expensive to cover the additional risk to the insurance company.
Sometimes non-guaranteed dividends are cheaper, but there is the risk that no dividend will be paid.
Are these dividends taxable?
Generally, with a few rare exceptions beyond the scope of this article, these dividends are not taxable. The tax authorities see dividends as a return of premiums to the policyholder.
Since they are not taxed, it is common for policyholders to receive cash or a check and reinvest in an investment to earn more income.
How can dividends be used?
The choice of how to use the dividend is up to the policyholder. This choice will affect either the death benefit or the cash flow elements of the policy.
Firstly, the dividend can be taken out as cash or a check from the insurance company. This “cash in pocket” option will pay more in the short term but could earn you less than over the long term from some other options.
Secondly, the policyholder can leave the cash with the insurance company. Thereby allowing it to accrue interest.
Thirdly, the policyholder can use the amount to purchase additional paid-up insurance. Again, this can be an excellentlong-term strategy as the policy size is thereby increased, as is the cash surrender value and, in turn, the death benefit value over time.
Fourthly, the policyholder can use the dividend to reduce the premium due. Finally, any excess can be used for other purposes.
The main takeaway
Consider your financial position and reasons for life insurance carefully before deciding.
Should you decide to go with a dividend option, it’s a good idea to compare life insurance policies that pay dividends to ensure that you get the best bang for your buck. Insurance companies compete for your business, so it’s a good idea to “shop around” before committing to a policy and its premiums!