Interest on Dividends
Definition
Interest on dividends refers to the income earned on dividend payments that are left on deposit with the insurance company. This scenario commonly occurs with participating life insurance policies. In a participating life insurance policy, policyholders receive dividends when the insurance company has lower-than-expected expenses and mortality rates, and achieves better-than-expected returns on investments.
Examples
- Life Insurance Dividends: A policyholder with a participating life insurance policy receives dividends based on the company’s profitability. They may choose to leave these dividends on deposit with the insurance company, where the dividends accumulate interest, which is subject to taxation.
- Accumulation Option: For instance, John, who holds a participating life insurance policy, opts to leave his received dividends with the insurance company. Over time, these dividends accrue interest. This interest becomes taxable income.
- Savings Account Analogy: Think of it similarly to leaving money in a savings account where the interest earned is subject to income tax.
Frequently Asked Questions
Q1: How are dividends on life insurance policies taxed?
- A1: Dividends themselves are generally not taxable. However, the interest earned on these dividends when left on deposit with the insurance company is subject to taxation.
Q2: Can a policyholder withdraw the dividends and interest at any time?
- A2: Yes, policyholders can usually withdraw their dividends and the earned interest at any time, but this could be classified as taxable income.
Q3: What tax forms should a policyholder expect?
- A3: Policyholders will receive a 1099-INT form from the insurance company, reflecting the interest earned on the deposited dividends.
Q4: Are all dividends from participating life insurance policies eligible for interest accumulation?
- A4: Yes, policyholders can generally choose to leave dividends to accumulate interest, though this option might vary by policy term.
Q5: What happens if the policyholder does not opt to leave dividends on deposit?
- A5: If policyholders opt not to leave dividends on deposit, they can take dividends as cash payments, reduce premiums, or purchase additional insurance coverage.
Related Terms with Definitions
- Participating Life Insurance: A type of life insurance policy that pays dividends to policyholders based on the company’s success.
- Dividend: A portion of insurance company profits paid to policyholders.
- 1099-INT Form: A tax form that reports interest income earned including interest on dividends.
- Mutual Insurance Company: An insurance company owned by its policyholders, often issuing participating life insurance.
Online References
- IRS Publication 550 - Investment Income and Expenses
- Investopedia - Participating Life Insurance
- The Balance - How Life Insurance Dividends Work
Suggested Books for Further Studies
- “Life Insurance: A Consumer’s Handbook” by Joseph M. Belth
- “The Handbook of Principles on Life Insurance and Growth” by Howard P. Dunn
- “Tax Planning and Compliance for Tax-Exempt Organizations” by Jody Blazek
Fundamentals of Interest on Dividends: Taxation Basics Quiz
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