This tax season was an uncertain, and in many cases, a stressful time for people. While we all want to pay our fair share of taxes, we’re also looking for ways to make money and mitigate some of the taxes we’re confronted with having to pay.
There are products that can provide tax savings, as well as understand how things like dividends can help us from a tax perspective. In this article, we’ll look at dividends; because when people think of their investments i.e. dividends, they usually think of profits paid to shareholders, hence taxes.
Let’s begin by taking a deeper dive into how dividends work with different products as you build a wealth strategy.
Dividends - Insurance Companies and Stock Companies
Both Insurance and Stock companies can provide dividends. But the word “dividend” causes confusion because it is most often used in connection with a public company paying a stock dividend.
A Stock Company - if you own stock in a public company that pays dividends, you might receive a quarterly check from the company or stock dividends, which come in the form of additional shares rather than cash. Dividends represent corporate earnings and are determined by a company’s board of directors.
A stock dividend fluctuates with the ups and downs of the market. Most people re-invest their stock dividends; and if the price of the stock goes down after that reinvestment, you have essentially “lost” your dividend, or must wait for the price of the stock to go back up in order to recover your dividend. Of course, you can take dividends in cash; in which case, you wouldn’t lose it.
Stock Insurance Company – these are traded on the stock exchange (publicly traded) so like other stock-oriented companies, they try to get the most dividends in the shortest amount of time for the profitability of their shareholders, not their policy holders.
Life insurance dividends - Most people are surprised that a life insurance dividend also represent earnings. There are two types of insurance companies; publicly traded (stock, as noted above) or owned by the policy holders (mutual). A mutual life insurance company can play a role in our savings and ability to liquidate money. By law, mutual companies must share ALL profits of the company with participating policy holders. Profits over and above monies set aside for legacy benefits and operating expenses are distributed back to policy holders in the form of dividends.
When you think about life insurance do you associate it with making money? It’s a financial tool that might provide powerful savings and income.
— You can learn more about strategy in our Precision Strategy Learning Section —
Dividends as they relate to insurance
In most cases, dividends have been paid out for the past 100 years. Recent announcements show life companies declaring their biggest dividend payouts ever for 2019.
Mutual Life Insurance companies share their profits with participating policy holders, via a dividend which is declared annually, usually around the end of the calendar year. *This dividend is listed as a dollar figure and sometimes only an interest rate.
But what does this mean (or should mean) to you? Do all life policies provide a dividend or cash value? Let’s look at some common policies.
Term:
Provides insurance for a specific period, such as 10, 15 or 20 years, and is renewable after those terms are up.
Generally have lower premiums than permanent insurance, but increase on renewal.
Does not accumulate cash value (no savings component).
Permanent (whole life and universal life):
Provides lifelong financial protection as long as the policy is in force.
• The premiums for universal life typically increase upon each renewal.
• The premiums for Whole Life remain the same for the life of the policy.
• Includes a savings component known as cash value; the longer you pay into your policy, the more its cash value grows. You can choose to cash in or borrow against your permanent life policy and use the funds as needed.
Although both are considered permanent, only a participating whole life policy will receive a dividend.
If dividends are paid and reinvested into the policy as paid-up additions, they become part of the guaranteed cash value and part of a new, higher basis or floor that increases future gains—both guaranteed gains and dividend payouts.
Cash value can never lose value and is guaranteed to grow by at least a minimum guarantee. Therefore, reinvested dividends cannot be lost due to a market downturn. And any dividends paid and reinvested ensure that any future cash value gains and dividend payouts are actually increased, unlike a stock dividend.
Paid dividends are also owned by the policy holders who are called “contractual creditors” with a right to vote for the Board of Directors.
These insurance companies consider the benefit and the protection of the policyholders and their beneficiaries. They are far more conservative, consider safer investments, and have the luxury of planning for the long haul. While not guaranteed, these are the companies that are likely to pay a dividend every year, even in turbulent economic times.
When looking through a wealth strategy lens, we consistently recommend a mutual insurance company and a permanent policy.
Taxes - Whole Life insurance dividends and Stock
Whole Life Dividends –
Fortunately for whole life policy holders, the IRS does define dividends as a return of excess premium and therefore not taxable. However, be aware that if you take dividends in cash, you can owe taxes on dividends paid over and above the amount of premiums paid. Dividends re-invested as Paid-Up Additions are not taxed.
Stock Dividends-
Cash dividends from public companies in the stock market are taxable. For those who invest outside of tax-favored retirement accounts like IRAs, it's vital to know what taxes on dividends you'll need to pay. Dividend income is taxable, but for some, the current federal tax rates on in the U.S. are lower than you'll pay on other types of income. A tax expert should be consulted for individual situations.
A bit more on Mutual Insurance Companies
Now that you know you can get a dividend from a mutual insurance company through a permanent policy, how does this relate to the wealth strategy? When you structure a life insurance policy the right way you gain certainty, liquidity, and tax benefits.
These advantages are why people like Walt Disney and Senator John McCain used this strategy.
You can receive the dividend in several ways—some of which are more tax-strategic than others. You can:
*Note: You can take “up to cost basis” tax-free, meaning you can take up to the amount you have paid into the policy tax free, then once you’ve received what you put in, you’ll have taxes to pay.
In each of the “no tax consequence” options, you can consider that money off-the-books for tax purposes.
Here’s an example: Let’s say you need to buy a car. You could take the dividend as cash, pay due taxes on it, and buy your car. . .OR you could reinvest the dividend into your paid up addition and take a loan against that pool of money to pay yourself—voila, you’ve got your car with no need to pay taxes on the money you borrowed from your savings component. Then you’ll pay yourself back and recapture the growth.
As you consider a policy for your financial strategy, you’ll want to talk with a financial strategist that understands the differences between companies and their policies - they aren’t all the same.
To reiterate, you should think about life insurance in connection with growing your wealth because it’s a powerful financial tool that provides savings and income.
— You can learn more about strategy in our Precision Strategy Learning Section —
