Participating whole life contracts usually pay dividends. There are five common dividend options:
Dividends can be used to reduce life insurance premiums. If this option is taken, the dividend is subtracted from the premium. The consumer merely pays the balance. This option is usually used when the policy owner wants to pay a reduced premium each year.
Dividends can accumulate at interest. If this option is taken, the annual dividend is allowed to accumulate in an account that earns interest. The consumer should be aware that the interest off this account is taxable. Furthermore, periodically to make sure that they are receiving market interest rates on the dividend accumulation account.
Dividends can be paid cash. Every year, the insurance company sends a consumer the amount of the dividend.
Dividends can be used to buy paid up additional insurance. Each dividend purchases a small amount of life insurance that requires no future premiums. This additional life insurance (which is called paid up additions) grows in cash value and pays additional dividends. This is often the option that is chosen when a consumer wishes to have an increasing amount of insurance or when there is a plan to build up additional cash value so someday there will be enough reserve to pay future premiums.
There is a dividend option that is called the fifth dividend option. When this option is in effect, the dividend is usually used to purchase term insurance equal to the cash value of the policy. This is usually used when a person buys a whole life policy and is planning that they may borrow from it heavily in the future. The idea is that the dividend would purchase enough term insurance to offset the reduction in the death benefit that is caused by the loan.
There are other dividend options that are emerging. Most of them are specific to a particular insurance company. Some insurance companies, for example, have allowed consumers to use their dividends to pay off policy loans.
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