Life Insurance Dividends & Illustrations
A life insurance dividend can be compared to a stock dividend. Just as a profitable company may pay dividends to shareholders, mutual insurance firms can distribute year-end cash surpluses among some policy holders.
How Life Insurance Dividends Work
Mutual insurance companies generate income through life insurance premiums and investments. Based on the expected mortality rate among policy holders, firms then estimate how much cash will be needed to meet obligations and pay business expenses. At the end of the year, if expenses have been less than expected, or investments have done well, the firm will have a surplus. Some of the surplus may be paid back to policy holders.
Dividends Are Not Guaranteed
In practice, life insurance dividends are distributed only if a mutual company ends the year with a cash surplus. The board of directors will determine whether a dividend should be paid, and how much will be distributed to policy holders. Companies may use part or all of surplus funds to expand the business, pay other obligations, or increase investments. Firms also may choose to keep surplus cash in reserve to meet future obligations. In years when a firm’s life insurance payouts and other expenses exceed income, dividends are not paid.
Qualifying for a Dividend
Dividends are paid to policy holders of participating whole life insurance policies. Owners of these policies are roughly equivalent to stockholders in a corporation. They can vote for the board of directors, and are generally the only policy holders entitled to a dividend. Holders of term life and other whole life policies are not eligible. Some firms may offer hybrid policies that offer both term and whole life coverage. It’s important to carefully compare policy terms to determine whether dividends are offered. As a participating whole life policy can increase in value, it will cost more than other policies.
Applying a Dividend
When dividends are paid, policy holders have several options. Holders can use the dividend to help pay the next year’s premium, reducing the annual cost of keeping the policy. The dividend can also be used to increase the amount of life insurance coverage in the policy. Over time, reinvesting dividends can increase the value of a policy substantially. Policy holders may also ask the mutual fund to invest the dividend, keeping it separate from the policy, but potentially growing in value along with the firm’s investments. Finally, policy holders may take a cash payment for the dividend.
Taxes on Dividends
The IRS regards dividends as a rebate on premium payments. As a result, dividend income is not taxable, unless total dividend payments exceed the amount of premiums paid over the years. If dividend payments are invested with the mutual company, however, all interest earned is taxable each year.
IRS rules do classify some dividend payments as taxable income. The taxation is meant to penalize policy holders who quickly invest large amounts of money into their policies to avoid taxes. A mutual firm can advise policy holders on controlling the growth of policies to avoid triggering the IRS rules.
Learn to Read a Term or Whole Life Insurance Illustration
Life insurance illustrations may seem like an overly complicated and indecipherable set of numbers, but for those who take the time to understand them, they can be valuable tools for comparing the prices of life insurance policies. A life insurance illustration is a set of projections of the money that goes into and out of the life insurance policy. These projections can give a potential policyholder an idea of what he or she can expect to pay in premiums in coming years, how much he or she can expect to receive back from the insurance company if the policy is terminated at any year after the policy has been in effect, and the amount that beneficiaries can expect to receive if the insured dies before the policy matures.
Prices will probably not vary greatly among insurance companies for those who purchase term life insurance policies. The premiums are based mainly on life expectancy, which is calculated from actuarial tables that are fairly standard in the insurance industry. Actuaries predict how long a policyholder may live according to age and lifestyle. A young person in good health who does not smoke can expect to pay lower premiums than an older person who smokes. The illustration for a term life insurance policy will reflect this.
Ask For Help If You Need To
Life insurance illustrations are more complicated for those who purchase whole life or variable life insurance policies. The illustrations for these policies will reflect premiums based on actuarial data on the insured’s life expectancy, but will also reveal how well the insurance company expects to do on investing the premiums. Interpreting these numbers may require the help of an accountant or financial advisor. The time and expense of doing so may be worthwhile, as the illustrations by different life insurance companies may reveal the financial strength of the companies, and may reveal how much of the premiums are going to pay sales costs during the first few years of the policy.
Compare Illustrations From Different Companies
What may seem like the best deal at first glance may not always turn out to be the best deal. Lower premiums may mean that a life insurance company may not be stable enough in the future to pay claims. An illustration that shows optimistic rates of return on investment may be unrealistic if a significant portion of premiums in the first few years of a policy are used to pay sales costs instead of being invested. A careful review of life insurance illustrations can provoke questions about these issues, which can lead to the best coverage at the most reasonable cost.