Whole Life Insurance Dividends Options
If you own a dividend-paying life insurance policy, you have some decisions to make. Dividends paid to your policy may be used for a number of purposes. However, how you use those dividends will affect how your policy performs and could affect whether you are taxed on money associated with your dividends.
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Paid-Up Insurance
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Allowing your dividends to buy additional paid-up life insurance grows your life insurance policy over time. Paid-up life insurance is life insurance that does not require additional insurance premiums to keep in force. Instead the death benefit purchased is "paid up" or "paid in full." This additional death benefit accelerates the cash value accumulation of the base policy, because there is a cash value associated with the paid-up insurance. On top of that, the cash value from the paid-up insurance generates its own dividends, which may be used to purchase additional paid-up life insurance. You do not pay income tax on dividends used to buy additional paid-up insurance.
Cash
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You may take the dividends as cash. If you do, the dividends are income tax-free as long as the dividends do not exceeds the total premium payments made to the policy. If they do exceed that amount, you are liable for income tax on any excess. In the latter case, this money is considered a gain in the policy.
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Reduce Premium
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You may use the dividends to reduce the premium you pay. Dividends used for this purpose effectively lower your out-of-pocket costs for the policy. A reduction in the premium may be so significant that the entire premium is paid from the dividend payment. There is no income tax due on premiums used this way, even if the dividends exceed the premium payments.
Accumulate Interest
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You may leave the dividends with the insurance company to accumulate interest. If you choose this option, the dividends never become part of the policy. Instead, the dividends are invested into the insurer's general account. The general account accumulates interest based on the investments of the insurer, which typically include bonds and other income-producing assets. This option does not trigger income tax on the dividends, but does trigger income tax on all investment interest you earn from the invested dividends. Like the cash option, you may take the dividends as cash at any time. If you do, you are not taxed on dividends unless you receive dividends that exceed your total premium payments to the policy.
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