Some life insurance policies claim to “participate.” A term that means policy owners are entitled to share in the insurer’s profits. When purchasing a participating whole life insurance it is important to understand how these profits are distributed and what financial implications follow.
(Most participating life insurance policies available will be whole life insurance policies. This article is specifically based on whole life participating policies, other types will not apply.)
Participating life insurance dividends
When profits surpass the insurance company’s expectations, policy owners of participating life insurance policies receive a share of the insurer’s profits by way of dividends. Dividends in life insurance industry vary from those issued by corporations.
Most insurance carriers that sell participating life insurance are mutual companies, and have no stockholders. When purchasing a participating policy from a mutual company, you become an owner-in-part of the company.
Additionally, the dividends are treated as a refund (or partial refund) of the premiums you pay for your policy—after all, you are a customer. This may appear a superficial or purely semantic distinction, but it allows policyholders to receive their dividends free of the onus of income tax. In the event that dividends received exceed a policyholder’s cost basis (total premiums paid to date), however, the excess is treated as taxable income.
Your life insurance policy will detail the options your dividend can be paid to you. You can opt for a simple cash payment or you could apply your dividend payment against future premiums. Since participating whole life insurance includes a “cash value” account, you can credit your dividend to your cash value.
Another option is to use your dividend to purchase additional participating whole life coverage and add to your current policy. Your death benefit will increase, but your future premiums will remain unchanged.
Evaluate the factors
Before you buy a participating whole life insurance policy, it is common to evaluate how your potential policy will perform financially under different scenarios and predict possible “what-if” factors. Although this is recommended, it is not safe to rely assumptions, but rather use it as an educated starting point.
Dividends are a share in the life insurance carrier’s profits and profits are never a guarantee. And keep in mind that the economy can have an effect on it.
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