Are Life Insurance Contract Dividends Reported As Taxable Income?
Some life insurance policies pay dividends. These policies are generally whole life policies sold by mutual life insurance companies. Mutual life insurers work for the benefit of their policyholders instead of stockholders. In this sense, there is no conflict of interest between you and outside shareholders of the company. When you receive dividends, make sure you understand how these dividends are taxed.
Other People Are Reading
-
Function
-
Life insurers that collect and invest premiums may choose to pay a dividend. The dividend is a reflection of the investment experience of the company. The investment experience means that the insurance company is successful in their investments. The other determining factor to life insurance dividends is the mortality experience of the company. Mortality experience refers to the amount of deaths the insurance company experiences in any given year. The more deaths an insurer realized, the fewer profits the insurer makes due to having to pay life insurance claims.
Benefits
-
The benefit of a dividend is that it increases the total cash value amount of the policy along with the death benefit amount by buying additional paid up insurance The dividend can also be used to reduce future premium payments, be set aside to earn interest or taken as cash. Dividends used to buy paid up insurance can be cashed in and withdrawn at any time.
-
Drawbacks
-
Dividends that are withdrawn as cash are taxable when they exceed the total premiums paid into the policy. This means that if you pay $7,000 in total premiums, your dividends will be taxable when they exceed $7,000. Dividends are taxable at ordinary income tax rates.
Misconceptions
-
A common misconception is that dividends represent a return of premium and are thus non-taxable. While this is the way that the IRS defines a life insurance policy dividend, it is possible to exceed the total premiums paid into the policy. When this happens, the dividend is actually considered a gain in the policy and is thus taxable. However, the taxation never takes place until you withdraw the dividend. Dividends inside of the policy are not taxable as income.
Considerations
-
Consider whether it is in your best interest to withdraw dividends from your policy, including the tax implications of your withdrawal. Make sure that you understand that by withdrawing dividends, you are permanently decreasing the size of the life insurance death benefit.
-
