By Barbara Marquand
The opportunity to earn an annual payout is a big selling point for whole life insurance.
Just as some life insurance companies pay a certain amount of cash per share when you own their stock, some insurers pay out a portion of their annual surpluses to policyholders. The payout is called a dividend.
Extra cash is always a good thing, but it's important to understand how dividends work before you start dreaming of how you'll spend the money. Here are five things to know:
1. Only mutual life insurance companies pay dividends
A mutual insurance company is owned by its policyholders. New York Life, Northwestern Mutual and MassMutual are among the largest mutual life insurers.
Stock insurance companies are owned by their shareholders and generally do not pay dividends to policyholders.
2. Only 'participating' policies can earn dividends
You have the opportunity to earn dividends only on "participating" whole life insurance policies, which are sold by mutual insurance companies. A whole life policy provides lifelong coverage and features an accompanying savings account called cash value, which grows over time. Once the cash value has built up, you can borrow against the cash value or surrender the policy for the cash.
You can't earn dividends on term life insurance, which provides coverage for a certain period, such as 10, 20 or 30 years, and has no cash value.
3. Dividends are not guaranteed
When you buy a whole life policy, the death benefit and the annual return on your cash value are guaranteed. But dividends are not.
After the mutual insurer pays claims and other expenses each year, the company determines whether to pay dividends and how much to pay.
4. The dividend amount is based on your policy's cash value
You could start receiving dividends after owning the policy for two years, according to industry group Life Happens. The dividend amount will be based on how much cash value your policy has at the beginning of the year. The longer you hold the policy, the more the cash value builds, and the higher the dividend you could earn each year.
- Pay a portion or all of the premium the following year.
- Buy term life insurance.
- Repay money you borrowed against the cash value.
- Purchase additional whole life insurance.
Dividends are a nice bonus if you hold on to a whole life policy for many years. Before you buy, remember that dividends are not guaranteed, and that it will take years to build enough cash value to earn significant payouts.
Barbara Marquand is a staff writer at NerdWallet, a personal finance website. Email: firstname.lastname@example.org. Twitter: @barbaramarquand.