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Are dividends on life insurance policies taxable?

Important things to know...
  • The IRS does not require you to pay taxes on dividends from life insurance as long as they do not exceed the premiums paid on the policy.
  • The insurance company that provides your life insurance pays policyholders dividends from its profits.
  • You can only earn dividends on whole-life insurance policies. Term life insurance policies normally do not build up cash values.

If you plan on pursuing a life insurance policy that pays dividends, here are a few things that you need regarding paying taxes on the dividends and the types of policies available to you.

Learn more about life insurance below and don’t forget to use our free comparison tool above!

Life Insurance Dividends and Taxes

adobestock_79402865-1600x1600The dividends you earn on life insurance policies are not taxable, according to Fox Business. The rule of thumb is since policyholders essentially paid for the insurance companies to earn a profit through premiums, the dividend payments are treated as refunds and therefore not taxable.

However, there are some specific yet rare instances when you must pay taxes on dividend payments. If the dividend payments you receive from the insurance company exceeds the amount you pay in premiums, you must pay taxes on those dividend payments.

Whole Life Insurance vs. Term Life Insurance

adobestock_111908338-1600x1600As you start to comparison shop for life insurance, you should know the difference between whole life insurance policies and term life insurance policies.

Whole life insurance policies, also known as permanent life insurance policies, offer you coverage throughout the course of your life. The premiums on whole life policies are usually fixed, and some policies provide you with savings features through dividend payments.

One of the biggest benefits of whole life policies is that you can increase the cash value over time.

As the cash value of your policy increases, you can access that money as a loan against your life insurance policy.

Term life insurance policies offer you coverage for a specific period of time, according to the terms of the contract. In order for your beneficiaries to receive a death benefit, you must die within the terms of the policy.

Term life insurance is usually cheaper than whole life, and the premiums for term life are generally less expensive. However, term life does not offer you savings features through dividend payments.

Using Dividends from a Life Insurance Policy

You can use the dividends from your life insurance policy in several different ways.

  • You can request that the insurance company use the proceeds to reduce future premium payments.
  • You can also request a check for the dividend payments from the insurance company, but you must keep in mind that you may have to pay dividend taxes on the funds from the check.
  • Additionally, many insurance companies offer you the option of keeping the dividends with them, and you earn interest on the dividends.

However, the IRS considers the interest earned on the dividends as taxable income. The IRS does not tax the actual dividends, but it does tax the interest that you earn from the dividends.

Choosing the Right Insurance Company

adobestock_38113283-1600x1600Since no two policies or insurance companies are the same, you must choose who pays dividends and how they pay their dividends carefully.

While you are comparison shopping, find out if the companies will pay their dividends in the form of checks and calculate whether or not you can earn a higher yield in another investment vehicle. You should determine how the dividends from your life insurance policy fit into your financial future.

Ask yourself if the dividends are just a way to lower your premium payments in the future or are the dividends a large part of your retirement plan.

Additional Tips on Buying Life Insurance

You must first determine if you actually need life insurance and for how long. If you are single with no dependents and plan on staying that way, you probably do not need life insurance.

However, if you know you need life insurance, choose a policy that you know you will stick with. While you are comparison shopping, do not forget to review the terms of the policy thoroughly.

Remember that the company’s answers to frequently asked questions must be complete and accurate, and when you do decide on a policy, make sure to completely review the application before you sign.

You can compare life insurance with our free comparison tool below!