You know the value of life insurance in protecting your loved ones, and you're familiar with important contract features, like the death benefit and cash value. But some contracts also offer a lesser-known benefit: dividends.
This article covers:
What are dividends in life insurance? How are dividends calculated? What is a dividend scale? When do you receive dividends? Are life insurance dividends taxable? How can you use life insurance dividends? What other insurance pays dividends?
What are dividends in life insurance?
A dividend is money an insurance company distributes to eligible clients when the company performs better financially than it expected for the year. You can think of a dividend payment as a partial refund of the premium you paid for your coverage. The board of directors is in charge of approving annual dividends.
Not every life insurance company or contract offers dividends. The contract must be participating, and permanent contracts are most likely to be participating. For example,
How are dividends calculated?
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- Investment returns: Insurance companies don't rely on contract premiums alone for their financial strength and stability. They largely generate their income from bonds, stocks, mortgage loans and other investments. When investment returns are higher than the interest rates an insurer offers contract holders, part of the surplus can go toward dividends on participating contracts.
- Expense savings: Like any business, insurance companies have operating expenses. When these expenses are lower than projected, the insurer may pass on some of those savings through dividends.
- Claims experience: Insurance companies need to make good on their promise to pay death benefits to a contract's beneficiaries when the insured dies. If claim payments are lower than expected, some of the savings can help pay dividends.
- Contract contribution: A contract with a larger cash value generally contributes more to the insurer's total amount available to pay dividends. That means it typically receives a larger dividend payment.
- Outstanding loans: A contract loan can be a direct recognition loan, so the loan may increase or decrease the dividend payment. A loan also can be a non-direct recognition loan, so the dividend payment is the same as if the contract holder hasn't taken out a loan.
Insurers may not put excess investment returns, expense savings and claims savings toward dividends, though. They may set aside some of the surplus for the future to bolster the company and its ability to pay future claims and dividends.
What is a dividend scale for life insurance?
A dividend scale is an insurance company's formula for determining the dividend rate for a participating insurance contract. When you purchase a participating contract, you get an illustration showing the projected dividends your contract could receive. Ideally, this illustration is based on conservative projections the company can deliver on or improve upon.
A contract's actual dividends depend on the insurance company's experience each year or its divisible surplus: the total amount available to pay dividends. And the dividend scale isn't the same for every contract. It depends on factors like the type and amount of coverage as well as the year you purchased the contract.
A change in the dividend scale can impact a contract's value. Your contract may have a cash value and death benefit as long as you pay your premiums on time and don't take out any loans against it. It also may have values that can increase when dividends increase—and decrease when dividends decrease.
Depending on the insurer and the insurance product, some participating contracts may not be eligible for dividend payments during the first couple of years. Your financial advisor and contract illustration can help you understand if and when a particular insurance contract may receive dividends
When do you receive dividends?
If you own a participating contract, you typically receive a dividend payment on your contract anniversary in years when the insurer issues a dividend. Some contracts also pay terminal dividends when the insured dies or the contract holder surrenders the contract.
While dividends aren't definite, Thrivent has paid dividends on eligible insurance products since 1913. In the last 10 years, the company has distributed more than $3 billion in dividends to its contract holders. Thrivent's consistent ability to pay dividends for more than a century reflects its enduring financial strength and stability in both good and bad economic and market conditions.
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Are life insurance dividends taxable?
Life insurance dividends are considered a return of premiums. Since they're essentially classified as a refund of sums you've paid, they're
Your dividends also may be taxable if the IRS classifies your life insurance contract as a
When dividends are treated as distributions from a MEC, however, they're typically taxable as ordinary income to the extent your contract's
If you're younger than 59½ when you receive a dividend (or other) distribution from a MEC, you also may owe a 10% penalty tax.
How can you use life insurance dividend options?
If your contract is eligible to receive dividends—one of the many potential
- Reduce out-of-pocket premium payments: The insurer can credit your dividend toward any premiums you owe. If the dividend is larger than the premium you owe, you can receive the excess as cash, let it accumulate at interest, reduce an outstanding loan or purchase additional paid-up insurance.
- Pay yourself directly in cash: The insurer can send you a check for the dividend amount. This option doesn't affect your contract values.
- Accumulate at interest: The insurer can credit the dividend to your contract and allow your dividend to earn interest. The insurer determines the interest rate and pays interest once a year. The interest is taxable as ordinary income in the year you receive it. Dividends you receive this way are referred to as your contract's dividend value.
- Minimize your loan payment amount: If you've borrowed against your contract, you can put your dividend toward repaying what you owe.
- Purchase paid-up additional insurance: You can
use your dividends to pay additional premiums to increase your contract's cash value and death benefit. To be "paid up" means you don't owe further premiums for your coverage. A contract's paid-up status can change with cash value loans or withdrawals. Purchasing additional paid-up insurance can increase your future dividends since you have a larger contract. In some cases, paid-up additions may be large enough to turn a contract into a MEC.
You can change how you receive dividends with written instructions to your insurer. Depending on the company's contract, you may be able to make this change at any time or only once per year. Your financial advisor can help you decide which choice may be best for your circumstances.
What other insurance pays dividends?
Life insurance isn't the only insurance product that may pay dividends. Long-term
Don't confuse the dividends paid to eligible life insurance contract holders with the dividends paid to life insurance company stockholders. Fraternal and mutual insurance companies are owned by their contract holders, who receive the company's declared dividends. (Thrivent is a fraternal insurance company.)
Shareholder-owned insurance companies also may pay dividends to their participating contract holders. However, if the company also pays dividends to its shareholders, then more people share the divisible surplus.
Get help finding a contract with dividends
A life insurance contract's death benefit may be its most important feature when it comes to looking out for the most important people in your world. However, the dividends you may receive when you own a participating contract can add even more value to it.
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