Are Life Insurance Dividends Taxable?

Life insurance can be an essential investment for helping to protect your loved ones if you pass away. However, death benefit coverage isn’t the only benefit of owning life insurance. It can come with several other features, one of which is life insurance dividends. Some insurers may pay these each year if they have excess profits, returning a portion of those funds to eligible policyholders. This article will explain how life insurance dividends work, then discuss when they may be considered taxable income.

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How life insurance dividends work

Life insurance dividends are a sum of money the insurer pays to each policyholder based on the insurer’s company profits.¹ Permanent life insurance policies, such as whole life insurance, generally pay dividends since they have cash value. Term life insurance does not pay dividends.

Insurers generally pay dividends annually. Also, keep in mind that dividends are separate from cash value earnings.

Are dividends from life insurance taxable?

Life insurance dividends are generally not taxable. This is because, in most cases, the IRS considers a life insurance dividend to be a return of premiums paid.¹ However, there are a few exceptions that we’ll cover in the next section.

When life insurance dividends are taxable

Here are some instances where life insurance dividends may be taxable²:

Your dividends exceed the total premiums paid

If the amount of dividends you receive is greater than the total premiums you have paid into the policy, the excess may be taxable. This is because any dividends over the amount you paid are considered income, not a return of premium.

For example, imagine that you pay $1,000 in life insurance premiums this year, and you receive a $1,250 dividend. You may owe taxes on the $250 excess.

You earn interest on dividends

You can leave your dividends in an interest-bearing account. However, the gains you receive may be taxable.

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How to use your life insurance dividends

Policyholders can elect to receive their dividends in several ways¹:

Receive your dividends in cash

Many choose to receive their dividends in cash. This can be a good way to add to your income, use the dividends for a specific purpose, invest the funds elsewhere, or recoup some of the costs of your life insurance without reducing your coverage.

Apply your dividends to future premium payments

You can elect to apply your dividends directly to future premium payments. This can help you pay part or all of your premiums. Applying dividends to premium payments can also help maintain coverage if you encounter financial problems in the future.

Let your dividends accumulate interest

You can choose to leave your dividends on deposit with the insurer to earn interest. As dividends and interest accumulate, the balance may continue to grow over time. Leaving dividends on deposit could help increase the amount available to you in the future.

Get paid‐up additional life insurance

Paid-up life insurance is one where no further premium payments are needed to keep the policy in force.³ You can use your dividends to purchase additional paid-up life insurance. This allows you to increase your coverage without increasing your premium payments.

Purchase one-year term life insurance

You can use your dividends to purchase one-year term life insurance. The amount of coverage available will depend on factors such as your age and the amount of dividends available. This can provide additional life insurance coverage for a limited period without increasing your premium payments.

Learn more about life insurance

Life insurance dividends allow eligible policyholders to share in the insurer's financial results. You can take them as cash, put them toward future premiums, leave them on deposit with the insurer to earn interest, or purchase more coverage without increasing your costs.

Regardless of how you choose to receive your dividends, keep in mind that you may owe taxes on any gains or amounts that exceed premiums paid. Tax professionals can help you determine whether you owe taxes on your dividends.

For more help understanding life insurance, please visit Aflac’s life insurance advice page. And if you’re ready to get a policy, speak with an agent about our life insurance options today.

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