Should I Take Out My Dividend First or My Paid Premium on My Life Insurance Policy

Overview of Life Insurance Dividends and Premiums

Life insurance dividends are payments made by mutual insurers to policyholders when the company performs better than expected. These payments are not guaranteed and depend on actual experience versus assumptions for mortality, expenses, and interest. Dividends typically arise from favorable investment returns, lower-than-expected claims, and operational efficiency. Policyholders can receive dividends in several ways, such as cash, reducing premiums, purchasing additional paid-up insurance, or accumulating interest. Understanding how dividends interact with premiums is important because using dividends to pay premiums can affect policy values, cash flow, and long-term goals. This article explains the options and considerations for deciding whether to take out dividends as cash or apply them toward premiums.

What Are Life Insurance Dividends and How They Work

A dividend in life insurance is a return of part of the premium when an insurer's actual experience is better than the conservative assumptions used to price the contract. Mutual insurers, which are owned by policyholders, commonly pay dividends, while stock insurers may pay dividends to shareholders rather than policyholders. Dividends are not taxable as income when received because they are considered a return of premium. However, they are contingent on the insurer's financial results each year and can vary or be zero in some years. Dividends may be used in several ways, and each option has different effects on the policy and the policyholder's finances.

Common Dividend Options

• Cash payment: Receive the dividend as a check or direct deposit.
• Reduce premiums: Use the dividend to pay all or part of the upcoming premium.
• Paid-up additions: Use the dividend to purchase small additional paid-up insurance, increasing death benefit and cash value.
• Accumulate at interest: Leave the dividend with the insurer to earn interest over time.

Policyowner Rights and Sources of Dividends

As a policyowner, you have the right to receive dividends in the form and schedule presented in your illustrations and policy summary. The dividend is not a liability of the insurer and is not guaranteed; it is effectively a share of the surplus generated by the insurer's favorable experience. Dividends come from three main sources: interest earnings on the insurer's portfolio, favorable mortality experience (fewer or less severe claims), and positive expense experience (costs lower than projected). Because dividends depend on actual results, they may differ from the amounts shown in non-guaranteed illustrations. Policy illustrations must disclose both guaranteed and non-guaranteed elements, which helps set realistic expectations.

How Using Dividends to Pay Premiums Affects Your Policy

Applying a dividend to the next premium reduces the out-of-pocket cash required to keep the policy in force, which can be helpful during tight-budget periods. However, this choice reduces the amount of dividend you receive as cash and can slow the growth of cash value if the dividend would have been used to purchase paid-up additions. Using dividends for premiums does not typically change the death benefit unless the reduction causes a premium to be missed and the policy lapses. It's important to track both the dividend amount and the premium amount to ensure that the dividend covers the intended portion and that the policy remains active. Over time, the impact of choosing premiums versus cash can be significant in terms of total cash value and net death benefit.

Dividend vs. Premium Impact Snapshot

Tax Treatment and Policy Considerations

Life insurance dividends are generally not taxable as income because they are considered a return of premium. However, if dividends exceed the total premiums paid under Modified Accelerated Cost Recovery System (MACRS) rules or in certain arrangements, a portion could be taxable. Whole life and universal life policies with cash value accumulation are the types of contracts that typically pay dividends, and they are designed for long-term objectives such as estate planning, cash value growth, and income replacement. Policy illustrations include both guaranteed and non-guaranteed values; the non-guaranteed values reflect dividend scales, interest rates, and mortality assumptions that may change. Policyowners should keep records of how each dividend option is selected, since the choice can influence the policy's performance and the owner's overall net worth.

Strategic Guidance and Practical Tips

If your priority is to lower current premiums and keep the policy active, using the dividend to pay part or all of the premium can make sense, provided the dividend is sufficient to cover the required amount. If you need liquidity, taking the dividend as cash may be preferable, but consider the opportunity cost of forgoing paid-up additions. A balanced approach is to use part of the dividend to pay the premium and allocate the remainder to paid-up additions or cash, depending on your goals. Review the current dividend scale, the insurer's financial ratings, and your policy illustrations annually to ensure your strategy aligns with your objectives. Consult a qualified insurance professional or financial advisor to tailor the approach to your specific situation and to monitor how dividend decisions affect cash value, premiums, and beneficiaries over time.

Bottom Line on Dividends and Premiums

You generally can use your life insurance dividend to pay your premium, and doing so can help manage cash flow and prevent lapses. However, this option reduces the cash you receive and may slow cash value growth compared to taking the dividend as cash or using it to purchase paid-up additions. The best choice depends on your liquidity needs, premium obligations, and long-term goals for the policy. Understanding how dividends are calculated, how they interact with premiums, and the tradeoffs of each dividend option will help you use them effectively within your overall financial plan.