Policyowner dividends are one of the many perks that can come with owning an insurance policy, but it’s important to understand how they’re taxed so you can plan your budget accordingly. This guide to how are policyowner dividends treated will show you what to expect from tax season.
Policyowner dividends, whether paid to owners of whole life or term life insurance policies, are commonly paid in the form of additional premium discounts or some form of additional cash value accumulation.
Either way, the fact that your policy is paying you additional money makes it important to understand how your state’s income tax department will treat this new income you’re receiving from your life insurance policy.
Although every state has different rules regarding this type of income, here’s what you need to know about how dividends paid by your life insurance policies are treated by your state’s income tax department.
Dividends are a distribution of profits, typically paid in cash or stock. Dividends can be classified as either qualified or non-qualified. Non-qualified dividends may be subject to a higher tax rate than qualified dividends.
The treatment of qualified and non-qualified distributions depends on the type of the company that pays the dividend, not the individual receiving it. In order for a dividend to be considered qualified under IRS rules, it must meet two requirements:
1) The shareholder owns at least 50% of the company that is paying the dividend, and
2) The shareholder has owned this stake for more than 60 days (exceptions apply).
A company may pay only qualified dividends if it does not have more than $10 million in gross receipts for any one taxable year. If the company has greater than $10 million in gross receipts, it may elect to pay some dividends as qualified and some as non-qualified.
How are policyowner dividends treated with respect to income tax? Qualified dividends receive favorable tax treatment with regards to capital gains taxes and investment income taxes. On the other hand, income from non-qualified dividends is generally taxed as ordinary income, which incurs a lower tax rate.
When Are Dividends Taxed?
Dividends are typically taxed as ordinary income, which means they’re subject to a higher marginal tax rate than long-term capital gains. For example, if you have a $100,000 salary and get paid a $10,000 dividend from your company, that $10,000 would be taxed at the same rate as your salary.
If the stock is held for more than one year before it’s sold or distributed, then it qualifies for long-term capital gains treatment. Long-term capital gains rates can be lower than ordinary income rates depending on your federal tax bracket.
For example, an individual in the 10% federal tax bracket will pay 0% on qualified dividends received from an investment held for more than one year. Whereas an individual in the 39.6% federal tax bracket will pay 20% on qualified dividends received from an investment held for more than one year
The Mechanics of Dividend Income
Policyowners receive a quarterly dividend based on the net income that their insurance company is able to generate. The dividend amount is calculated by dividing the net income by the total number of policies and then multiplying that number by 100%. This percentage is then multiplied by the dollar amount of each individual policy.
The Internal Revenue Service (IRS) defines a dividend as a distribution from earnings and profits, whether in cash or in other property. Therefore, any distributions made from an insurance company’s earnings are considered dividends for tax purposes.
If your policy has a pre-determined rate of return, you must also include those amounts when calculating your dividend amounts. The IRS gives preference to taxpayers who show dividend income over those who earn interest. As such, the standard deduction can be used to offset up to $1,200 of interest and/or qualified dividends before they’re taxed at normal rates.
Additionally, qualified dividends are typically taxed at a lower rate than ordinary investment income – 15% vs. 39.6%, respectively; this creates a potential opportunity for tax savings through long-term investments within stock markets, retirement accounts, and real estate investment trusts (REITs).
Policyowner Distributions by Type
Policyowner distributions may come in the form of a cash payment or a return of previously paid premiums. The type and value of the distribution determines how it is taxed. For example, if it is in the form of a cash payment, the distribution is taxable income for that year and must be reported on your federal tax return.
If the distribution is made up of previously-paid premiums, it may be subject to a 10% penalty for early withdrawal as well as taxation at your ordinary income rate. There may also be additional state taxes imposed on these types of distributions based on where you live or have an office.
Some distributions may also be subject to an additional 3.8% tax on net investment income, which affects high-income earners. The purpose of that tax is for funding health care for certain people in high-income brackets who do not otherwise receive coverage.
In short, distributions from a life insurance policy or annuity can have both taxable and non-taxable components depending on how they were accumulated by the policyholder over time.
What Is a Non-Qualified Distribution (NQD)?
A Non-Qualified Distribution (NQD) is a withdrawal from an annuity that isn’t made in accordance with the Internal Revenue Code. Most insurance companies will tell you about this when they send out your quarterly statements, but it’s important to understand how the NQDs are taxed.
A non-qualified distribution may be taxable income, or it may be considered a return of principal. If the distribution is a return of principal, no tax needs to be paid and the distribution can continue until all funds have been returned.
The taxation of a non-qualified distribution depends on two factors: how long you’ve owned the annuity, and whether or not your annuity is part of an employee retirement plan at work. For example, if you own an annuity that was purchased within five years before the distribution, then any NQDs will likely be fully taxable as ordinary income.
But if your annuity has been open for more than five years and is part of a retirement plan at work like a 401(k), then up to 85% of any withdrawals may be taxable as capital gains instead of ordinary income! You’ll want to speak with your financial advisor or CPA for more details about how these rules apply to you specifically.
Do insurance companies pay dividends to policyholders?
It is important to understand how insurance companies treat your dividend, as it will determine how much of the dividend is considered taxable and how much of the dividend will be reinvested in your policy.
If the company pays a cash dividend, the company may withhold federal income tax on that amount. The company may also withhold state income tax on that amount or pay a state income tax reimbursement on behalf of the individual.
Does term life insurance pay dividends?
Term life insurance does not pay dividends. The only time a term life insurance policy pays a dividend is when the insured person has died, and there is no longer a risk of their death.
Does Liberty Mutual pay dividends?
Liberty Mutual does not pay dividends on the funds in its life insurance and annuity contracts. When a policyowner dies, Liberty Mutual pays the proceeds from their life insurance or annuity contract directly to their beneficiary.
The amount that is paid out varies depending on the type of contract and the age of the deceased.
Will MassMutual pay dividends in 2022?
MassMutual is the nation’s largest mutual life insurance company, based in Springfield, Massachusetts. The company offers a wide variety of products and services including annuities, life insurance, and mutual funds.
MassMutual pays quarterly dividend payments to its policyowners. These payments typically range from 2% – 6%. In 2022, MassMutual will pay its policyowners a $2 per share quarterly payment.
What are dividends payable to a policyowner?
Dividends payable on life insurance policies in some states are not taxable for federal income tax purposes. Dividends payable on life insurance policies in other states may be subject to federal income tax, but may also be excludable from the policyowner’s gross income and taxed at a lower rate than dividends paid on shares of stock.
Are dividends paid to policyholders taxable?
Dividends paid by insurance companies in the form of shares or other property are not taxable. However, if the company pays a dividend in cash, then the dividend is taxable and must be reported on your income tax return.
Policyowner dividends represent the return of your investment and, therefore, they are not subject to income tax. However, they must be reported on the IRS form K-1 and must be included in your taxable income. If the total amount from Form K-1 is greater than your gross income for the year, then a portion or all of the dividend may be subject to an additional 10% early withdrawal penalty for pre-591⁄2 distributions.
The exception is when you roll over a policy owner dividend into another qualified retirement plan or individual retirement account (IRA). In this case, there would be no early withdrawal penalty because it is considered as part of your required minimum distribution (RMD) calculation.