Policyholders are placed in rating classes according to physical
characteristics, including age, sex, and medical history. If your life insurer has to pay out a higher-than-expected number of death claims in your class, you are less likely to get a dividend.
You
might assume that younger folks would receive more in dividends than
seniors because younger people are less likely to die. However, James
Reiskytl, vice president of tax and financial planning at Northwestern
Mutual Life Insurance Co., says premiums are calculated such that older
people pay more in mortality and expense (M&E) fees — the cost the
insurer charges you to assume the risk of insuring you — and thus get
back a higher dividend because they pay more in premium. Thus, older
people have the same chance of receiving the amount younger people
receive, he says. Still, it's possible that some policyholders will receive
dividends when others won't, regardless of how much a particular group
pays in M&E fees. Life insurers "don't want to reward a class [of
policyholders] if there are a lot of unknowns and they have a poor
track record," says Michael Bartholomew, senior counsel for the
American Council of Life Insurers.
Those who own whole life and universal life insurance
policies may receive dividends, while people who own term life
insurance policies will not. That's because the cash value in a whole
or universal life insurance policy is a fixed rate guaranteed by the
insurer and funded through money in the company's reserves. In turn,
the investment return on its reserves is one factor that determines
whether the insurer will pay a dividend. Term life insurance
policyholders do not receive dividends because there is no underlying
cash value that earns interest.
Variable life and variable universal life insurance
policyholders may receive dividends if there are a lower-than-expected
number of death claims in their rating class and the insurer managed to
keep down its expenses. However, these policyholders are less likely to
receive dividends than whole or universal life insurance policyholders
because earnings on the cash value — one factor life insurers use to
determine whether they will pay a dividend — are not fixed or
guaranteed. Instead, the cash value in variable policies is based on
the performance of subaccounts, which are investment options that may
include mutual funds.
If
your insurer issues you a dividend, you can take it in cash, buy
additional insurance coverage, or apply the money toward your premium.
For life insurance policies, you also can pay off loans you may have
taken against your whole life policy. In most cases, your dividends won't end up in Uncle Sam's
pocket. Dividends from auto and homeowners insurance policies are
tax-free.
Life insurance policy dividends are taxable only when the
amount you receive in cash exceeds the amount of premiums you have
paid. The dividends are taxable only if you take them in cash. If you
use your dividends to buy paid-up additions to your policy, they are
not taxable. Dividends also may be taxable if your life insurance
policy is a modified endowment contract, which is a policy that's
overfunded in order to build up greater cash value. Dividends on
modified endowment contracts are taxable unless the money is used to
buy paid-up additions to your policy. (For more on life insurance and
taxes, check out Insure.com's Life Insurance & Annuity Tax Tool.)
Insurance
companies often pay dividends to keep customers from defecting to other
insurers, says Hartwig of the III. Insurers think a check at the end of
the contract year — no matter how small — is incentive enough for
policyholders to renew their coverage and not seek lower rates or
better coverage elsewhere. "At the end of the year, the last thing a person sees from their
insurer is a check," he says. "That can go an awful long way in keeping
that customer." Return to Page 1
