Dividend Paying Whole Life Insurance: How Does It Work?


If you are exploring ways to protect your family’s financial well-being, you may have come across permanent life insurance as one option. Whole life insurance is a type of life insurance that millions of Americans own, and it has its strengths and downsides, just as other life insurance kinds do.

As a permanent life product, whole life insurance lets you build cash value. It also offers a guaranteed death benefit, predictable premium payments, and the possibility of dividends that can pay your premiums or provide you with cash.

In later times, you can borrow against the cash value or use it eventually to pay premiums and keep your policy in force. Among the best benefits of whole life insurance are the payment of dividends and the fact that any dividends you earn will most likely be tax-free.

Life insurance policies are either participating or non-participating. A participating policy pays dividends to policyholders. These policies are usually sold by mutual insurance companies (which are owned by policyholders). Non-participating policies don’t pay dividends.

In this article, we will go over some basics of dividend paying whole life insurance so you have a foundation about which you can ask your financial professional for more information.

Basics of Dividend Paying Whole Life

Here are a few fundamentals to keep in mind for dividend paying whole life.


In the case of whole life insurance policies, dividends represent a small portion of the issuer’s profits. These dividends are similar to those paid on the profits of a public company. The dividend amount usually depends on the amount paid into the policy.

A $100,000 policy paying 5 percent will pay $5,000 for the year. If the policyholder adds another $5,000 during the following year, the policyholder will receive $5,250 the next year. Eventually, these dividend payments can increase to levels that will offset some of the costs associated with owning the whole-life policy.

Dividends can be guaranteed or non-guaranteed, depending on the policy. Most often, policies that provide guaranteed dividends also have higher premiums. In contrast, non-guaranteed policies have lower premiums but may go years without paying dividends.

If the dividends are important to you, check out the insurance company’s financial rating. A life insurance company with an excellent rating is generally more able to reliably guarantee and sustain dividend payments. If ratings matter to you, then you may want to stick with insurance companies with a rating of A or better.

Using Your Dividends

Once you receive your dividends, you have various options for using them. You can request a check for the dividends and deposit it into your accounts. On the other hand, you can also use your dividends to offset a portion of the premium due or to purchase additional insurance.

You may also leave the dividend with the life insurance company to earn interest. Dividend payments can also reduce the balance of any loans against your policy’s cash value.

Reasons for Dividends

Dividends represent the insurance company’s profits from policy premiums.

Effect on Premiums

You can use your dividends to pay all or part of your premiums. This strategy will reduce the premium you owe on your policy or may eventually pay off the policy in its entirety.

How Do Dividends Work?

At its base, dividend-paying whole life insurance works like all whole life insurance. The policyholder pays premiums for coverage that will last for life and has a cash value component. You can make loans against the policy to access your money. However, any unpaid loans will be deducted from the policy when you pass away.

For a dividend-paying policy, you will receive dividends if the issuer has a profitable year. When considering a dividend-paying whole life policy, your agent or financial professional should give you policy summaries that project how much you can expect from each policy for annual dividends.

Tax Treatment of Whole Life Dividends

Perhaps the best feature of whole life dividends is that they aren’t subject to federal income taxes in many cases. Dividends are treated for tax purposes as a return of premium by the life insurance company and are thus taxed similarly to other distributions.

They will be distributed income-tax-free until your investment of funds in the contract has been reduced to zero. In other words, if you buy a $100,000 whole life policy and over the years you own it, you receive dividends totaling $100,001, that last dollar may be subject to income taxes.

The dividends are a tax-free refund of overpayments of premiums to the extent of how much premium you have paid.

Getting Tax-Free Income from Whole Life

As noted above, dividends aren’t taxable income so long as the total of dividends received doesn’t exceed the cost of your policy.

Because dividends only get paid if your insurance company has a financial surplus, the IRS treats the dividend payout as a refund of excess premium payments. If you leave your dividends with the insurer to earn interest, that interest will get taxed as income.

Questions to Ask Before Buying

Be sure to ask your agent or financial professional these questions before committing to a whole life insurance product.

How Are Dividends Calculated?

The first step in calculating a whole life dividend is determining whether the insurance company experiences financial performance that exceeds its assumptions for that fiscal year. The insurance company considers the assets it needs to maintain its capital position and its overall performance.

Once the company determines that its results support the payment of dividends that year, it will evaluate each individual eligible policy. Certain expenses and credits are applied to the policy to determine is Guaranteed Accumulated Value.

Among these critical statistics are the company’s investment returns and the mortality expense (claims experience) the company has had for the year before. The company then applies the premium percentage to that number.

Are Dividends Guaranteed?

Dividends can be guaranteed or not guaranteed. The former policy will be more expensive because it imposes a higher risk on the insurance company, which must pay the dividend regardless of its financial performance. On the other hand, if receiving dividends is crucial to you, the higher cost may be justified.

Some insurance companies use a dividend scale in conjunction with calculating dividends. This chart is a complete set of dividends on a policy. It will begin with the dividend payable in the current year and then show what the dividends in succeeding years would be if there were no changes in the current calculation factors. The company will prepare and distribute a new divided scale if there are material changes to those expenses.

Effect of a Change in Dividend Scale

For a guaranteed dividend policy, you will always receive at least the minimum dividends so long as you have no loans and promptly pay your premiums. The payment of dividends won’t affect the guaranteed cash value or death benefit of your policy.

On a non-guaranteed policy, your cash value and death benefit can change. If, for example, you received an illustration, that illustration will be based on the dividend scale in effect at the time of the illustration. If it changes, so will the values in your policy.

Effect of Loans on Dividends

Depending on the nature of your policy, an outstanding loan may affect the dividends your policy earns. If your insurance company uses the direct recognition methods to calculate dividends, the insurance company will adjust the policy’s dividends to reflect the funds the company couldn’t directly invest.

Of course, outstanding loans also impact the cash value of your policy and the death benefit payable to beneficiaries.

Does the Life Insurance Company Have a Good Track Record?

Since you are looking for dividend payments over the life of your policy, and these payments are only guaranteed by the claims-paying ability of the issuer, make sure that your insurance company has a solid financial history. Otherwise, you may get to retirement and find you have never received a premium. Or what’s more, the death benefit on your policy may at that point be in question.

Should You Pay Premiums with Dividends?

You can pay your premiums with the dividends, but taking the cash in hand provides the most options. So long as they are likely to be income-tax-free, this latter is probably your best option.

Will You Pay Income Tax on Your Dividends?

So long as your total dividends received haven’t exceeded your total payments for the policy, your dividends will be deemed a refund of excess paid premiums. They therefore won’t be taxable.

Pros and Cons of Dividend Paying Whole Life

If you need whole life insurance and can handle the premiums, owning a dividend paying whole life policy can be beneficial. They can help pay premiums, provide income tax-free cash-flow, and provide a death benefit.

However, dividends shouldn’t be the only factor you consider when choosing life insurance. Think about whether you actually need cash value insurance rather than term life. Also, examine the financial standing of the issuer of any policy you are thinking about. It’s good to keep in mind that your policy is, in the end, only as good as the claims-paying ability of your issuing insurance company.

Another thing is that insurance policies aren’t investments. Their growth potential for money is generally lower than what you can find for products offered in the investment marketplace, such as stocks or mutual funds.

On the other hand, the level of risk faced to have that growth potential is also considerably lower. The critical decision is to examine your entire financial plan and determine the role of various insurance products in your plan.

A licensed insurance professional with broad experience in retirement financial issues can help you make these decisions.

Finding the Right Insurance Professional for Your Goals

If you are looking for an agent or financial professional to assist you, consider working with someone who is independent. In other words, they are someone who isn’t beholden to one or a few insurance companies, but rather can offer products from multiple carriers.

An independent financial professional has more business freedom to research solutions that fit your situation and then recommend them to you. They also don’t have quotas or other business requirements to meet with a parent financial company or insurance carrier, unlike captive financial professionals.

If someone who is independent and experienced in retirement financial services sounds appealing to you, many independent financial professionals are available here at SafeMoney.com. You can get started by visiting our “Find a Financial Professional” page and connecting with someone directly there. Feel free to request an appointment to discuss your goals and situation, and if you need a personal referral, please call us at 877.476.9723.

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