Buying life insurance provides peace of mind and security for those who depend on you financially. If your life insurance is a dividend-paying, whole life policy, you must choose what to do with the dividends. Regardless of what you choose to do, dividends add value to your life insurance.
Whole Life Dividend Options
Certain life insurance policies earn dividends from the insurance company -- the dividends are a portion of the profits earned by the insurance company. When you apply for a whole life policy, you must decide what to do with the dividends earned on the policy. The dividends can be paid out to you as cash, or you can use the dividends to reduce the annual premium. Alternatively you can allow the dividends to accrue and earn interest, which allows you future access to the money if you need it; or you can use the dividends to buy paid-up additions, meaning that each dividend buys a small amount of additional life insurance.
Dividends Accrue at Interest
Leaving dividends to accrue at interest is a little bit like keeping the money in a savings account. Your life insurance dividends accumulate, and the insurance company pays interest too. If you use this option, the face value of the life insurance policy stays the same. When you die, this face value plus the accrued dividends would be paid to your beneficiaries. In the meantime, however, choosing to let the dividends accrue at interest gives you flexibility to withdraw some or all of the money if you need it. This money is considered taxable income.
The paid-up additions option uses each annual dividend to purchase an additional amount of life insurance. The result of a paid-up addition is a larger amount of life insurance. In turn, each paid-up addition builds its own cash value and also earns dividends. The cash value build-up is tax-deferred under the tax rules for life insurance cash value.
Choosing Between the Two
Selecting paid-up additions produces both an increased death benefit and increasing cash value. Leaving dividends to accrue at interest allows you to access the cash build-up without affecting the life insurance coverage. The life insurance agent should show you the projected dividends and cash value for each of the options, so you can make the best choice for your situation.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.