If you own a whole life insurance policy, you may be entitled to receive a portion of the insurer's profits in the form of dividends. Insurance companies typically declare dividends on an annual basis, although there is no guarantee as to their amount or whether they will be declared at all. If your company issues dividends, you have some choices regarding how you use them. Two common options include allowing them to accrue interest or using them to purchase additional insurance.
Using your dividends to purchase paid-up additions means that your dividends purchase additional life insurance coverage at no out-of-pocket cost to you. As with the cash value of the basic policy itself, the dividends also have cash value that can earn additional dividends. Leaving your dividends to accrue simply means that you allow the dividends to earn interest, which will compound over time. Because you are not using the dividends to purchase more insurance, your cash value will grow at a much greater rate with this option.
Future Insurance Needs
If you plan to have a family, your life insurance needs are likely to increase as your family grows. This can make using your dividends to purchase paid-up additional insurance the better option. You will increase your insurance coverage automatically without having to pay additional premiums. Paid-up additional coverage does not require medical underwriting, so you can still increase your coverage even if your health declines.
Building a Cash Fund
The accruing option means you will have more cash available. With whole life insurance, you can withdraw from the accumulated cash value in the form of a low-interest loan. You can use the cash for any purpose you wish, such as covering a financial emergency, paying for your kids' college education, taking a vacation or making a down payment on a home.
The two dividend options have different tax implications. If you choose the accruing option, the interest the dividends earn is viewed as taxable income. However, with paid-up additions, the cash value that the additional insurance accumulates grows on a tax-deferred basis, just as it does with the base policy. If you are concerned about minimizing your tax liability, the paid-up additional insurance option would be the better choice.