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How To Earn Dividends Through Life Insurance
What type of life insurance earns dividends?
There is insurance for almost anything. One of the most popular forms is life insurance, which is used to insure policyholders in the event of their death so their beneficiaries will be financially protected in the aftermath.
Life insurance policies can be roughly split into two main categories: term life insurance and whole life insurance.
Term life insurance covers the policyholder for the term agreed on in the contract. A 20-year term is common for this type of policy, but some terms can last anywhere from 10 to 40 years.
Whole life insurance lasts the entire life of the policyholder. These policies come with premiums that are generally much higher than term life insurance premiums. Aside from the increased length of coverage in whole life insurance, there are a few other perks.
Some whole life insurance policies pay policyholders a return on their premium, also known as dividends—these policies are known as participating life insurance policies. Not all whole life insurance policies pay their policyholders. Some are known as non-participating policies, which means they will not give out a return on investments.
We’ll walk through how to earn dividends from life insurance, and what to watch out for when navigating the insurance industry.
What are dividends for life insurance?
A dividend is a payment shareholders receive when their investment makes money. Much like other forms of investments, some life insurance policies will pay policyholders a share of the company’s profits.
These dividends are usually not guaranteed—they depend on the financial performance of the life insurance company. When an insurance company has excess profits after paying their yearly operating expenses, they may use those excess profits to pay dividends to their policyholders.
To earn dividends with a life insurance policy, you’ll need to sign up for a participating policy, commonly offered with whole life insurance.
Earning dividends from a life insurance policy holds some tax benefits. The IRS does not consider life insurance dividends to be taxable income. The IRS considers these dividends to be a return on premium, essentially meaning the policyholder overpaid into what the insurance company needs to operate.
Conversely, term life insurance does not pay dividends because the policies do not hold value, unlike whole life policies.
A term life insurance policy can be thought of as a “rented” life insurance policy that the policyholder only has claim to over the term stated in the contract.
What do participating policy contracts mean?
Insurance terminology can be intimidating and confusing but they don’t have to be. “Participating Policy Contract” is one of those terms that sounds a lot more complicated than it actually is. Breaking the term down will make it easier to understand.
All insurance policies are contracts, which means they are agreements between the policy owner, you and the insurance company. The contract in this case boils down to this: you promise to pay a regular premium for a set amount of insurance, and the insurance company promises to pay the face value of the policy (contract) to your beneficiary upon your death.
The participating part in this case refers to your participation in sharing in the profits of the insurance company. Participating policies are usually a whole life policy that pays dividends. The dividend is a portion of the insurance company’s profits that are paid to policyholders as if you were an investor or stockholder. The policyholder is generally offered several choices of what to do with the dividends when they are paid.
“Participating policies are usually a whole life policy that pays dividends”
What to do with policy dividends?
Although dividends are usually not guaranteed, life insurance companies will pay them out if the company makes an excess profit for the year. These dividends are paid out in relation to the value of the whole life insurance policy.
The more the life insurance policy is worth, the greater the dividends can be. The dividend payment usually takes place on the anniversary of when the policy contract was signed by the policyholder.
Depending on the contract details of the whole life insurance policy, people might have a few choices on how they would like their dividends to be paid out. Each choice has its own merits.
Here are the common methods for a life insurance dividend payment:
- Premium payment: This option allows policyholders to use their dividends against their premium payment. By paying the dividends back into the policy, the premium will be reduced.
- Insurer savings account: This option allows policyholders to keep their dividend payment in a cash account maintained by the insurance company. The company will reinvest the dividends. Over time, the dividends will earn interest in the account and become more valuable.
- Increase insurance: This option allows policyholders to use their dividends to purchase more life insurance coverage. Using dividends in this way will increase the value of the life insurance policy, which could lead to greater dividends in the future.
- Cash payment: This option allows the policyholder to receive a cash amount for their dividend payments, usually in the form of a check.
When signing up for a participating life insurance policy, read the contract details thoroughly. There may be some restrictions on how policyholders can manage their dividend payments.
If you are signing up for a participating policy with a dividend strategy in mind, check if that strategy will be allowed under the terms of the policy.
Dividends and income taxes
“Dividends earned from a participating life insurance policy are not taxable by the IRS”
Dividends earned from a participating life insurance policy are not taxable by the IRS. Participating policy dividends are not taxable as income because they are not dividends in the traditional sense. While they do represent a portion of the insurance company’s profit, that profit was made from you. In essence, the IRS treats them as though they are refunds for overpayment of premium.
Not all policies guarantee dividend options
Dividends are shares of the insurance company’s profit, and as anyone who watches the stock market will tell you, profits go up and down, which means dividends can and will vary over time. Participating policies even from the same provider may be different, which is why it is very important to ask and read your contract. When companies guarantee a dividend, it usually means a higher premium – a portion of which is ultimately used to pay you.
“Participating policies even from the same provider may be different, which is why it is very important to ask and read your contract”
Not all insurance companies are created equal, and when you consider purchasing a participating policy, an important consideration should be the relative strength of the insurer. A.M. Best and Standard and Poor’s both employ analysts whose sole job is to watch over insurance companies and grade their performance.
The higher a company’s rating, the more likely they will pay the projected dividends being offered. The difference between an A, AA and AAA rating may not be significant enough to sway you from choosing one insurer over another, but the differences may become substantial when you drift below an A rated provider.
“Not all insurance companies are created equal, and when you consider purchasing a participating policy, an important consideration should be the relative strength of the insurer”
Dividends are calculated differently by different companies, however they are generally based on the current cash value of your policy. Northwestern Mutual’s dividend formula is a simple and effective way to get the right number. Consider these numbers using it:
$58,367 cash value
X 3.29% interest rate
$ 1,923 your dividend
The advantage is that over time as your cash value increases, your dividend increases as well. You may never get rich from participating insurance dividends, but they can go a long way to increasing your coverage or paying down your premium. As you might expect, they require time and patience to reap the reward.
The top life insurance companies to earn dividends
When it comes to gaining dividends, some life insurance companies are better than others. In this review, we favored mutual life insurance companies with strong financial ratings.
Mutual life insurance companies are owned by their policyholders as opposed to privately held insurance companies, which are not owned by policyholders. Although some privately held life insurers also offer dividends, there is an advantage to signing up with a mutual life insurance company.
Mutual life insurance companies will not spend profits in ways that do not benefit policyholders, like large corporate bonuses, for example. Financial strength is important because a life insurance company must be financially stable in order to ensure life insurance payments for the foreseeable future.
Good: Northwestern Mutual
Northwestern Mutual offers customers three tiers of life insurance: term, whole and universal policies. While a whole life policy will have a fixed premium over the life of the policy, a universal policy features premiums that can be adjusted year to year, which could offer policyholders an investing advantage.
Northwestern Mutual holds top marks from financial strength ratings organizations, including a A++ rating from AM Best.
Founded in 1860, Guardian is one of the largest mutual life insurance companies in the U.S. The company is structured around maximizing long-term benefits for it’s policyholders. In 2020, Guardian announced a $982 million dividend payment to policyholders, which represents the largest dividend payment in the company’s history.
Guardian is also a top-rated life insurance company in financial strength, earning an A++ rating from AM Best.
Best: New York Life
New York Life is wholly owned by its policyholders and has no outside shareholders. It’s the largest mutual life insurer in the U.S., and New York Life is even ranked in the Fortune 500. New York Life agents are trained in high net worth markets and increasing returns on policyholder investments.
Like the other companies profiled here, New York Life has a perfect A++ rating from AM Best and top marks from other financial strength rating institutions.