The word “dividend” is often thrown around so loosely that its meaning gets confusing. Thus it is important to note the difference between Life Insurance Policy dividends and Investment dividends.
An investment dividend is a payment made by a corporation to its shareholders, usually as a distribution of profits. When a corporation earns a profit or surplus, the corporation is able to re-invest the profit in the business and pay a proportion of the profit as a dividend to shareholders
Cash dividends are the most common form of payment and are paid out in currency, usually via electronic funds transfer or a printed paper check. Such dividends are a form of investment income and are usually taxable to the recipient in the year they are paid. When the dividends are reinvested, like in an IRA, the taxes can be deferred to a later date.
The main thing to note here is that investment dividends are taxable. If you bought the shares via a broker, that broker will send you a 1099 at year’s end telling you and the IRS how much you received during the year.
Life Insurance Policy Dividends
Policy dividends are a “return of premium,” which means that if your insurer had an overall good year, it will give you back part of the premium you paid for your insurance policy. However, it is important to note here that dividend payments received from life insurance policies aren’t subject to taxes by the IRS, since the insurance companies generated the gains off of their policyholders. In essence, the dividend payments are treated as refunds for overpayment of the premium.
Don’t be fooled
A dividend as it relates to investing is a payment to you and a dividend as it relates to life insurance is a return of some of your overpayment that you made to them. Life Insurance was never meant to be an investment and the two should be kept as far apart as possible.
Here are some ways that life insurance companies make policy dividends look so good:
By using the word dividend in the first place, it just sounds like a good thing.
They might also tell you that with stock dividends, they are only concerned with paying the shareholder. However, with policy dividends, we are more concerned with paying our policy holder.
Furthermore, they often pay dividends to keep customers from defecting to other insurers. They 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. (If they only knew it was their own money.)
Insurance companies pay dividends not only to pass on perceived savings to policyholders, but also to get a substantial tax break. Dividends are subtracted from a company’s income, thus lowering the amount of taxes it must pay.
The Bottom Line
Keep your Insurance and Investments separate. Buy lower cost Term Life Insurance and you will surely have more money for, perhaps, putting it towards dividend-paying investments.