How dividends were supposed to pay premiums?

Written by Hannah McCullough Insurance Researcher & Writer

Participating whole life policies can pay dividends when the insurer declares them. A dividend can reduce the amount you send with a premium payment, but the policy contract and the insurer’s current dividend decision control the result. The National Association of Insurance Commissioners (NAIC) describes a participating policy as one that may pay dividends and calls a life insurance dividend a refund of part of the premium.

What are dividends on a life insurance policy?

Life insurance dividends are non-guaranteed amounts a participating policy may pay to its owner. They are not the same as stock dividends, and they do not turn a policy into a bank account. The NAIC explains that a participating policy may pay dividends and that a life insurance dividend is a refund of part of the premium. Read the contract to see how the policy defines the dividend and which values are guaranteed.

Dividend decisions reflect the insurer’s experience and the policy’s terms. A favorable result does not force the insurer to pay a particular amount next year. Your illustration may show a current dividend scale, but a scale is not the same as a guaranteed benefit. The useful question is whether the policy still meets your need if the dividend is lower or zero.

How can a dividend reduce the premium payment?

A policy owner can usually elect to have the insurer apply an available dividend to the next premium. That reduces the amount the owner pays from a bank account. For example, if the premium due is $1,200 and the declared dividend applied to it is $300, the remaining payment is $900. The $300 is not a permanent discount because the next dividend may change.

The IRS specifically describes insurance-policy dividends that an insurer keeps and uses to pay premiums as not taxable. That treatment does not make the premium disappear from the contract. Keep enough cash available to pay the full contractual amount, and check the annual notice to see whether the insurer applied the dividend automatically or requires an election.

What other choices can you make with a life insurance dividend?

Depending on the contract, the owner may be able to take the dividend in cash, leave it with the insurer to accumulate, use it to buy paid-up additions, or apply it to premium. These choices do different work. Cash provides current liquidity. Accumulation leaves money with the insurer. Paid-up additions can increase policy values and coverage under the contract.

Those elections are not interchangeable. The NAIC advises consumers to ask whether policy values change from year to year and what part of the policy is not guaranteed. Compare the written illustration and the policy provisions, not just the current dividend amount. If the notice lists more elections, evaluate each one against your cash needs and the coverage you want to keep.

Are life insurance dividends taxable?

Life insurance dividends are generally not included in income until the contract has returned more than the total net premiums paid, but the tax result depends on the policy and the transaction. The IRS says dividends on insurance policies are a partial return of premiums and should not be included in gross income until they exceed total net premiums paid for the contract.

Interest credited on dividends left with the insurance company is a separate issue. The IRS says interest paid or credited on accumulated insurance dividends is taxable interest income. A cash election, a premium election, an accumulation election, and a paid-up-addition election can have different consequences in a particular contract. Ask a tax professional about your policy before making a choice based only on a general rule.

How do policy loans change the dividend decision?

A policy loan uses available cash value as collateral, but it creates a balance that can accrue interest under the policy terms. The NAIC explains that unpaid loans plus interest are subtracted from the death benefit, so a loan can leave beneficiaries with less than the face amount.

If a policy offers fixed versus variable policy loan rates, read how each rate is set, how often it can change, and whether the policy uses direct or non-direct recognition for dividends. Those details are contract-specific. Do not assume that a dividend will offset loan interest or that borrowing leaves the policy’s projected values unchanged.

What if the insurer declares a smaller dividend?

If the declared dividend is smaller than the amount in an illustration, the owner may need to pay more of the premium out of pocket. If no dividend is declared, the contractual premium still matters. The NAIC recommends asking which policy values are guaranteed and whether premiums or benefits vary from year to year. Use those guaranteed terms as the baseline for your budget.

Review the annual statement and dividend notice when they arrive. Check the declared amount, the election on file, the premium due date, any accumulated balance, and any loan interest. If a planned dividend election no longer fits your budget, contact the insurer or a licensed life insurance agent before missing a payment.

Is a participating whole life policy right for you?

A participating whole life policy may fit someone who wants permanent coverage and is comfortable reviewing non-guaranteed values. It may be a poor fit if the budget depends on an assumed dividend or if the owner needs the lowest initial premium for a fixed period. The NAIC notes that cash-value policies include a savings feature and that premiums tend to be higher because of that feature.

Before buying, ask for the guaranteed and non-guaranteed columns of the illustration. Ask what happens if the dividend scale changes, whether the premium must still be paid in full, and how a loan affects values and the death benefit. Compare the policy’s long-term obligations with the coverage need you are trying to solve. A current dividend is one input, not a reason to skip the contract details.

What should you check before using dividends to pay premiums?

Start with four documents: the policy, the current illustration, the dividend notice, and the loan provision if you have borrowed. Confirm whether the dividend is applied automatically, whether the insurer can change the election, and how the policy treats cash, accumulation, paid-up additions, and premium payments.

• Write down the full contractual premium, even when a dividend currently reduces your payment.
• Mark which values are guaranteed and which depend on a dividend scale.
• Ask how an outstanding loan changes interest, cash value, and the death benefit.
• Keep a cash reserve for a year in which the dividend is smaller than expected.

If you want help comparing the coverage need with a realistic budget, you can see your estimated rate in minutes. An estimate is a starting point, not a promise that a policy will be approved or that a participating policy’s dividend will cover a future premium.