Term life policies offer the cheapest way to buy life insurance coverage, but they have never successfully displaced whole life policies. This is because there are numerous advantages a modified whole life insurance has to offer that simply isn’t matched by lower-priced coverage. These include guaranteed death benefits, consistent premiums, and dividends. Dividends can be used to reduce the overall long-term cost of life insurance or even pay out cash.
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Many insurance companies make it a policy to share a portion of their profits with policyholders. Those who hold qualifying life insurance policies receive a regular share of the public company’s profits, not unlike the dividends paid to shareholders in a publicly-traded company. Total dividend payments typically depend on how much money the policyholder has paid into his or her policy.
Here’s a basic example.
A policy that delivers a four percent (4%) annual dividend will deliver $2,000 per year if the total policy is worth $50,000. If this policyholder chose to increase the policy’s value by $3,000, this would increase the dividend for the subsequent year by $120, for a total of $2,120.
Different whole life policies treat their dividends in different ways. Most of them fall into the categories of “guaranteed” or “non-guaranteed.” Guaranteed dividends will always be paid out, while non-guaranteed dividends depend on the company’s overall profitability.
To the policyholder, the difference is typically seen in the overall cost of the policy. Premiums tend to be higher with guaranteed dividend policies to make up for the greater risk the insurance company is taking on.
When picking a whole life insurance policy, a potential policyholder needs to consider the overall strength and integrity of the insurance company when considering dividends. The company’s credit rating is a useful benchmark for judging the value and reliability of its dividends.
Does Credit Rating Matter?
Insurers tend to guard their credit carefully, resulting in high ratings (A or better) from credit agencies. Companies that do not secure an A rating need to be investigated thoroughly before an individual commits to buying whole life coverage.
How Can Policy Dividends Be Used?
Policyholders receiving dividends from their whole life policies can put these windfalls to work in a lot of different ways. Some of the most common uses are described below.
Many insurers allow dividends to be handled automatically, reducing the amount of administrative hassle for the policyholder.
- Cash/Check: Dividends can be paid directly to the policyholder. Note that dividend taxes may apply.
- Premium Deduction: Dividends can be used to defray the cost of future premium payments.
- Savings: Many insurers offer to keep policyholders’ dividends in an interest-earning account for long-term savings.
- Coverage Increase: Dividends can be put towards purchasing more insurance or making pre-payments.
Dividends are an attractive feature that set certain whole life policies apart from their competitors. They can be employed in many ways. Before committing to a given policy, insurance buyers need to familiarize themselves with how an insurer calculates dividends, whether the dividends are guaranteed, and how they can put the income to work.
Tax regulations generally make it advisable to take dividends in cash and then reinvest the money, but sometimes alternative arrangements are more suited to the individual policyholder’s needs.