An accumulation option is a feature of permanent life insurance that reinvests dividends in the policy, where they can earn interest. Some insurance types pay annual dividends to policyholders. Accumulation is one of several choices policyholders have for using those dividends.

How does it work?

As you may know, life insurance has two types: term and permanent policies. Accumulation options are available with all types of participating permanent life insurance.

Dividends paid under accumulation options are treated as a tax-free return of capital as long as they remain in policy cash value, or inside buildup.

If dividends are withdrawn, amounts above the return of capital would be taxable. If taken as a loan, however, the entire amount would remain tax-free.

No cash value is paid at the insured's death, only the death benefit. In whole life, the death benefit can often grow with cash value because dividends automatically buy small insurance policies that increase the face amount. Upon surrender, only cash value is available for withdrawal. Taxes would be due if total cash value exceeds all premiums paid into the policy.

 

A policyholder can also use dividends to pay part of existing premiums or receive them immediately in cash. Dividends are not guaranteed, although some insurers have paid them annually to whole life policyholders for more than 100 consecutive years.

Some insurers allow policyowners to contribute money directly to the cash value account.  

Types of accumulation options

Here are the five accumulation options in a whole life policy.

1. Cash option: The policyholder receives cash dividends.
2. Premium reduction: The policyholder subtracts the dividend from the premium due and sends the difference to the insurer.
3. Accumulation at interest: Dividends remain in the equivalent of an interest-bearing savings account for the policyholder. A minimum interest rate is guaranteed, but a higher rate may be credited if conditions warrant. Accumulated dividends can be withdrawn anytime. Otherwise, they are added to death proceeds or the nonforfeiture value if the policy is surrendered.
4. Purchasing paid-up additions: Each dividend buys, based on attained age, a small amount of additional fully paid whole life insurance. Purchase rates contain no expense charge, and no evidence of insurability is required.
5. Purchasing term insurance: Some insurers offering what is sometimes called a fifth dividend option use part of the dividend to purchase one-year term insurance equal to the policy's current cash value. The remainder buys paid-up additions or accumulates interest. In either case, the term insurance is purchased based on the insured's attained age.

 

Dividends beyond accumulation options versus paid-up additional insurance

Policyholders can also use dividends to buy more insurance, called paid-up additional insurance. These additions also build cash value and earn dividends.

Cash value and dividends grow tax-deferred. Paid-up additional insurance is usually the default option unless otherwise specified. It increases the total death benefit and cash value the owner can borrow against or receive upon surrender.

This can suit a policyholder with a family whose insurance needs will grow. Paid-up additional coverage requires no medical underwriting, making it an easy way to increase coverage even if health deteriorates.

Annual dividends can also be applied toward premiums on the policy anniversary to reduce out-of-pocket costs. After several years, the annual dividend may exceed the annual premium, eliminating premium payment requirements.

Are accumulation options taxable?

Dividends paid under accumulation options are tax-free while remaining in policy cash value. That changes when withdrawn: amounts exceeding return of capital are taxed. If taken only as a loan, the entire amount would be tax-free. Interest earned on accumulated dividends is taxable in the year credited and, depending on circumstances, may result in income tax withholding.  

How do you pay taxes when exercising stock options?

Selling shares purchased by exercising stock options produces taxable income or a deductible loss. According to the IRS, this is treated as a capital gain or loss in most cases. However, special holding-period requirements must be met; otherwise, sale proceeds are treated as ordinary income.  

Can accumulated dividends be redeposited after withdrawal?

No. Accumulated dividends cannot be redeposited once withdrawn. They are no longer part of the policy and are subject to tax.  

An accumulation option allows dividends to accumulate in permanent life insurance. When a policyholder chooses it, insurer-provided dividends are reinvested rather than withdrawn so they can earn interest. Accumulation is one of several options policyholders can consider when deciding what to do with dividends.