How Life Insurance Dividends Work

Ross Quade | Life Insurance | 15 Apr, 2014 | No Comments

When you purchase a permanent life insurance policy, you likely will be given the option to earn dividends when your policy does better than what the market expects. This can be returned to the policyholder in a number of different forms, but most of the time, this return does not earn any type of tax that you have to pay. If you are not sure when you will have to pay tax or when you won’t, here are some basic guidelines to help make understanding the process easier.

How You Can Get Dividends Back

There are numerous ways that policy owners can receive their dividends back from the insurance company. The most common way is to use the earned dividends as a way to purchase additional coverage for the very policy the dividends came from. This adds to the total policy, and earns the policyholder additional dividends the next time the policy is doing well. This can be a revolving opportunity for policyholders to keep adding to their policies over the years, when the market is doing well. Additionally, the insurance company could also send you a check in the amount of your dividends, but it actually comes back to you as a return of your premiums, allowing it to be tax-free for you.

Other Options

Another option that policyholders have is to use their dividends to pay for future premiums, lowering the total monthly payment that a policyholder has to pay. This can make buying and keeping life insurance a little more affordable for people looking for a better way to make ends meet. Finally, policyholders have the option of going through and taking those dividends and using them as an investment within the very company they earned them through. This can give them a portfolio to start earning additional income through, and be able to start that investment with a tax-free initial investment.

When You Will Need to Pay Taxes on Your Dividends

There are a few specific times where you will have to pay taxes on your dividends. Typically the most common reason you’d have to pay taxes is because you cashed in your life insurance policy. This makes nearly anything you’ve earned from the policy open for the IRS to tax on. You will also have to pay some taxes if you transfer the policy to someone else, either by assignment or by selling the policy. You will likely also be required to pay some taxes should the policy fail to meet what the IRS defines as a standard life insurance contract. Aside from these, most of the time your dividends will not require you to pay any type of tax on them.

What About Taxes After Death?

Fox Business author, Bonnie Lee, recently discussed one area that seems to be a bit confusing. She brings up that dividends may be taxable after death, if again the dividends exceed the policy’s premiums. This will show up to the person responsible in the form of a 1099-DIV that will be due the next time this person pays yearly taxes.

After looking over the different ways that you can receive dividends and when you will have to pay taxes on them, you should have a better understanding of how these types of policies work. Anyone that is just now looking into these types of life insurance policies can rest easier knowing that only specific circumstances can come back and force you to owe taxes to the government. Don’t be afraid of what you could get back from your policy, embrace it and use it to your financial advantage with the method that best suits your needs.

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