What Type Of Life Insurance Pays Dividends? Whole life insurance is the only type of life insurance that pays policyholders an annual dividend. Other forms of life insurance including term life, variable universal life, and traditional universal life insurance do not pay dividends.
What Is a Life Insurance Dividend?
A life insurance dividend is a cash payment made by the life insurance company to the owners of whole life insurance policies. Dividends are made on the policy anniversary date every year. While not guaranteed to be paid every year by the life insurance contract, most major life insurance companies have made dividend payments every for over a hundred consecutive years.
Dividend payments are made to owners of whole life policies as a way for the owners to share in the profitability of the company. Traditionally, this is because life insurance companies were organized as mutual companies. In a mutual company, the policy owners are actually the owners of the company. Dividend payments are meant to distribute profits to the owners. Nowadays, life insurance companies are not always organized as mutual companies, but even if the company is organized a different way the company still needs to pay dividends on whole life policies in order to be competitive with mutual companies.
What Type Of Life Insurance Pays Dividends?
Whole life insurance will pay dividends as long as it is a “participating” policy. This term means the owners of whole life participate in the financial gains of the company. Not every whole life insurance policy is participating, however, the majority of policies are. A nonparticipating policy may be less expensive on an annual basis, but it will not enjoy the same type of long term value in terms of return on investment. You should always purchase a participating whole life policy since it is financially favorable over the long term.
Some companies offer dividend paying whole life insurance policies which means the policies pay dividends. These policies are also known as participating whole life insurance, because the policy owners (rather than the stockholders) participate in the profits generated by the company, by receiving dividends.
How Do Life Insurance Dividends Work?
Life insurance dividends actually bear a close resemblance to the dividends you would receive from any other type of investment, where you share in the returns of the company you invested in.
Dividends can be determined differently for privately held companies (called stock companies) and mutual companies, and policyholders have a number of options for how to use their life insurance dividends.
Dividend amounts also can change each year and are not guaranteed. And dividend-paying whole life insurance policies tend to charge higher premiums.
How much money you earn in dividends depends on how much you pay into your policy.
While premiums can get pretty costly with whole life, the dividend amount can grow over time, alleviating some of the weight of your premium costs.
How Are Life Insurance Dividends Paid Out?
Your dividend is paid out on the annual policy anniversary (the date it was purchased) the year after which the dividend was earned.
While it is a set standard across life insurance companies, the way you receive your dividends is up to you.
Policy dividends can be paid out in four main ways, and you have the choice to pick which method makes the most financial sense for you.
- Cash: The insurance company sends you a check for the dividend amount.
- Premium Payments: Your dividend can cover and pre-pay your premium.
- Savings: Dividends may be deposited in your policy’s cash value and allowed to earn interest.
- Increased Coverage: Dividends added to your policy’s cash value may be used to buy paid-up coverage that increases your death benefit.
You can use your own financial goals to determine which type of payout to opt for, though many elect to have the dividends go into the policy cash value to continue to grow.
If saving money for the future is your overall goal, then you could use your money to pay your premiums, offsetting the cost or covering it all together, or buy even more insurance.
If you have no need for the money today and wish for the dividend payment to benefit your loved ones later, you could add the dividend to your policy’s cash value, letting it accumulate interest alongside those funds.
How Can Dividends Be Used?
Dividends can be used in a few different ways. The owner has a choice about how to use dividends, which balance cashflow and death benefit growth. The options for dividends are:
- Take it as a cash payment. This will pay you more money in the immediate term, but possibly less over the long term than other options.
- Use it to purchase additional paid-up insurance. This will increase future dividends because it increases the policy size, and it increases the cash surrender value. This is a great way to compound the growth rate of the policy and grow the death benefit.
- Use it to offset premium due. This reduces the amount of premium by the amount of the dividend. Any excess over the total premium due can be used for other purposes.
- Use it to accumulate interest in cash. You can store the dividend value in cash and get paid interest. This can increase the cash value over time with compounding interest and savings.
Why Don’t Other Life Insurance Types Pay Dividends?
It may seem like whole life insurance owners are unfairly incentivized to buy whole life, vs other types of life insurance. There are a few reasons why other types of life insurance do not pay dividends though, and they are good reasons.
- Term life insurance competes on price. It is pretty much a commoditized product, and clients usually choose the lowest priced option. Life insurance companies would have to raise premiums on term life policies in order to pay dividends, and it wouldn’t make sense to do this.
- Term life insurance is not permanent. Whole life insurance owners get to participate in the perks of ownership because they are truly buying into their policy for a lifetime.
- Tradition is a factor. Whole life insurance is the original form of life insurance. Mutual companies were organized based upon the sale of whole life products.
- Universal life pays interest instead of dividends. Universal life insurance pays owners on their cash value in a different way. Interest accrues on the cash value and is paid into the policy.
- Variable life insurance cash is invested in subaccounts that invest in capital markets. These are like mutual funds and growth happens if these investments perform well. The cash that whole life insurance owners hold in their policy is used by the life insurance company for their own investments. In a universal and variable universal policy, the life insurance company does not benefit the same why by investing cash value on their own behalf, like they do with whole life.
The type of policy an owner ultimately chooses (participating or nonparticipating) depends in part upon the ultimate use of the policy. If you as a prospective owner see the possibility that the cash value will be accessed as income or loans, or if you can afford to pay slightly higher premiums in the beginning years of the policy for the advantage of having the policy “paid up” or self-sustaining with dividends at some point in the future a participating dividend-paying policy will be most advantageous. If you prefer lower premiums and only foresee the need for the policy to continue for the whole life of the insured for the lowest annual amount, a nonparticipating policy may be for you.
It is wise to compare the cash value accumulation outcomes of both participating and nonparticipating policies when you are considering the purchase of a whole life insurance policy. By seeing the actual illustration it can give more perspective on how the dividend will help pay for the policy and provide income, or how much less the premium payments may be on a non-dividend-paying policy.