Policy Loan and Withdrawal Provisions

suspended premiums

An option that is available to policyowners who have let their policy dividends accumulate at interest is to use the accumulated funds to suspend premium payments. The length of time for which premiums can be suspended is dependent on the value of the accumulated dividends (plus interest); the larger the account, the longer premiums can be suspended.

Sue's annual premium is $1,500 and the declared dividend was $200. If Sue chooses the premium reduction dividend option, she will receive a premium notice for which of the following? $200 $1,700 $1,500 $1,300

$1,300

In addition to the four basic dividend options, various combination dividend options are available. Most combination dividend options involve which of the following? additional insurance (determined by the dividend amount) of the same type as the base policy permanent life insurance in $1,000 increments term life insurance in $1,000 increments one-year term life insurance

one year term life insurance

receive the dividend in cash

Under the cash dividend option, the policyowner simply elects to receive the dividend in cash. The insurance company sends a check for the amount of the declared dividend on the anniversary date of the policy. Policy dividends received in cash generally are not income taxable.

Gloria chooses to take her life insurance policy dividends in cash. The insurance company sends a check for the amount of the declared dividend on the anniversary date of the policy. What is the tax consequence to Gloria for receiving cash dividends? Her dividends are tax deferred. Her dividends are only income tax-free if Gloria is over age 62 ½. Her dividends are not income taxable. Her dividends are fully taxable.

her dividends are not income taxable

paid-up insurance

A less common dividend option, the paid-up insurance option, lets the policyowner use the dividends to pay up the life insurance policy early. A policyowner who chooses this option could pay up a whole life policy several years early, depending on the policy. After the policy is paid up, the policyowner does not owe any more premiums and the policy benefits continue in force.

buy paid-up additions

Under the paid-up additions option, the dividend buys additional paid-up insurance of the same type as the base policy. For instance, a $300 policy dividend on a whole life policy would be applied to buy an additional amount of paid-up whole life insurance. (The premium rate for the paid-up additions is based on the attained age of the insured when he or she buys the addition.) As each year's dividends are applied to buy these paid-up additions, the age at which they are bought increases each year. And because the age increases, the premium rates for the additional insurance increase each year, too. Paid-up additions are life insurance policies in their own right. As such, they are eligible for dividends and they each have a cash value that grows over time. Upon the insured's death, the total death benefit equals the face amount of the policy plus the face amount of the paid-up additions. Over time, the cumulative effect of these expanding policy values can greatly enhance the policy's total value—all for the same premium in effect when the policy was issued.

reduce the premium

Under the premium reduction option, the insurance company uses the dividend to reduce the next premium due. Suppose, for example, that the annual premium was $1,000 and the declared dividend was $250. In such a case, the policyowner choosing the premium reduction dividend option receives a premium notice for $750.

Dividend options

Participating life insurance policies include provisions that enable the policyowner to choose how he or she wants to apply any declared policy dividends. These most common options, known as dividend options, are receiving the dividend in cash; applying the dividend to reduce the premium; leaving the dividends with the insurer to accumulate at interest; using the dividends to buy additional paid-up life insurance; and using the dividends to buy one-year term insurance. Policyowners may change their selected dividend option at any time. However, if the new dividend option increases the pure insurance risk to the insurer (e.g., to the one-year term option), the insurer can require the insured to submit evidence of insurability.

Which statement about the accumulation dividend option is NOT correct? Participating policy dividends are not generally taxable. The dividends are retained in the insurer's general account. The policyowner can only withdraw the accumulated dividends and interest on the policy's anniversary date. The insurer credits a rate of interest to the dividends as they remain on deposit with the insurer.

The policyowner can only withdraw the accumulated dividends and interest on the policy's anniversary date.

accumulate at interest

Under the accumulation option, the insurer holds the dividends in an interest-bearing account for the policyowner. The policyowner can withdraw the accumulated dividends and interest at any time. While dividends are generally not taxable, the interest earned on dividends held at interest is taxable income in the year credited. This holds true regardless of whether the policyowner withdraws the interest earnings or allows the interest to continue to accumulate.

buy one year term insurance

In addition to these four basic dividend options, various combination dividend options are available. Most of the combination dividend options involve one-year term life insurance. They are often referred to collectively as the fifth dividend option. Under the fifth dividend option, policy dividends are used to purchase one-year term life insurance. Depending on the specific option selected, the term life face amount may equal the base policy's cash value or it may equal the amount bought with the dividend. If the first option ("equal to cash value") is elected, it is likely there will be some left-over dividend amount. In that case, the unused dividend can be applied to any of the other four basic dividend options. Whichever term life option is selected, the additional coverage is provided through a one-year term life policy that expires one year after issue. Because the term life face amount consists entirely of pure insurance protection, it represents a greater risk to the insurer than any other dividend option. If the policyowner requests a change to this option after the policy is issued, the insured will be required to provide evidence of insurability.

Dividend basics

Policy dividends are payable only with participating life insurance policies. They are most commonly issued by mutual insurance companies. A participating policy is one that participates in the insurer's divisible surplus, which is determined after accounting for liabilities (including death benefit payments), reserves, capital, and expenses. Participating policy dividends are effectively a return of unearned premium. As long as they do not exceed the total premiums paid by the policyowner, they are treated as a tax-free return of premium. (Since life insurance premiums are not tax deductible, it is only fair that a return of premium would be tax free.) Dividends are not guaranteed. While insurers try to pay policy dividends consistently, they (and their producers) may not under any circumstances state or imply with certainty that policy dividends will be paid. This prohibition against guaranteeing policy dividends applies to producers, too.