Many life insurance policies today have a provision allowing the policyowner to participate in the favorable experience of the insurance company through dividends. Most, but not all, of these participating policies are sold by mutual life insurance companies rather than by stock companies. Policies that do not pay dividends are called nonparticipating (nonpar) policies.
Many of the dividend paying companies pay the dividends annually. The policyowner usually is offered several options for the settlement of these dividends. The following is a list of possible dividend payment options:
- Cash dividend
- Accumulation at interest
- Paid-up additions
- Reduce premium
- Accelerated endowment
- Paid-up option
- One-year term option
When dividends are possible in partcipating policies, it is common for clients to believe that the dividends are earnings similar to those associated with stocks. But dividends are a return of premium and therefor are not taxed. And dividends are never guaranteed. Let’s take a closer look at the dividend options.
Cash dividend option- the insurance company simply issues a check to the policyowner.
Accumulation at interest- the policyowner can let dividends accumulate at interest with the insurance company. If the insured policyowner dies then the accumulated dividends and interest are paid to the beneficiary.
Paid-up additions -when a policyowner chooses to use dividends as a single premium to buy additional life insurance protection. The amount of paid-up addition per $1 of dividend is based on the insured’s age at the time the paid-up addition is purchased. No new policies are issued. The base policy is simply amended to reflect the additional paid-up values. Each of the additions will also develop cash value. The face amount and the additions make up the total death benefit. Proof of insurability is not required.
Reduce premium dividend option- the policyowner can direct the life insurer to apply the dividend towards the next premium due on the policy.
Paid-up option- the option allows the policyowner to pay up the policy early. For example, the insured has a 20-pay life policy. By using the dividends over the life of the policy, it may be paid up after 16 or 17 years.
One year term dividend option- directs the life insurance company to use the dividends on the policy to purchase term life insurance. The term policy is for one year.