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Whole Life Dividend Tax Treatment - Part 2

John "Hutch" Hutchinson | Founder, Banking Truths



Whole life dividends are generally not taxable since they are considered a return of premium. However, dividends can be taxable when the amount returned to the policyholder in cash exceeds the total amount they paid in premiums. Also, if the policyholder chooses to have their dividends accumulate at interest with the insurance company, the interest will be taxable.


These rare cases where dividends get exposed to tax can be easily avoided. Only take dividends in cash up to your basis (amount of premiums paid), and then borrow against your policy after that since loans are tax-exempt. Plus, your entire cash value balance (including the dividends you didn’t take out) keeps earning guaranteed interest as well as more non-guaranteed dividends.


Since both paid-up additions and accumulate-at-interest are potential dividend options, let’s explore these dividend options below.


Whole life dividends can be used with any of these 5 dividend options:

  1. Buy paid-up additional insurance (PUA)

  2. Earn interest from the insurance company

  3. Pay some or all of your premium due

  4. Pay down an outstanding policy loan

  5. Paid out to you in cash

Once your annual whole life dividend is declared you have any of these options, and you can also change how your dividends are allocated in any given year.


Let’s drill a little deeper into each option.


Dividends to Purchase Paid-Up Additional Insurance (PUA) – When using dividends to purchase PUAs, only a very small portion (5%-10%) goes to buying the paid-up insurance, while the lion’s share of the dividend payout will roll back into your policy cash value. It will be added to your guaranteed cash value, getting that steady growth rate every year going forward as well as helping you to claim a bigger cut of future dividend payouts. Plus (unlike the accumulate at interest option) the growth you get from PUAs remains sheltered from taxation inside your whole life insurance policy.


Dividends to Accumulate at Interest – With “accumes” you have the insurance company pay you an annual taxable interest rate on your dividends. So, although your dividends technically do accumulate-at-interest, this interest rate is often paltry, not to mention it would be taxable since you left the tax sanctuary of the policy.


Dividends to Reduce Premium – Whole life insurance dividends can pay your premiums. You can always apply your dividend payout dollar for dollar to reduce how much premium you’re required to pay on your base whole life insurance policy.


Dividends to Reduce Loans – You can apply your dividend payout dollar for dollar to reduce any outstanding policy loan balance you have.


Dividend in Cash Option – By electing the cash dividend option, you can have your whole life insurance dividends paid to you outright in cash. Whole life dividends are considered by the IRS to be a refund for an overpayment of prior premiums. Therefore, the cash dividend option is not taxable to you so long as they do not exceed how much you’ve paid into the policy in terms of total premium. As previously discussed, you can always take a loan against your policy if you need tax-exempt cash.


For more regarding this topic, follow this link.

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