Primerica Life Producer Practice Test

What is true about the taxation of dividends in participating policies?

1. Dividends are taxable as income

2. Dividends are not taxable

3. Dividends are taxed upon withdrawal

4. Dividends are subject to capital gains tax

The correct answer is: Dividends are not taxable

In the context of participating policies, dividends are not taxable as income when they are received by the policyholder. This taxation treatment arises because dividends from life insurance policies are considered a return of premium rather than income. Essentially, when policyholders receive these dividends, they are receiving a portion of the premiums they have already paid, which is not subject to income tax. It is important to note that these dividends can be used in several ways, including being taken as cash, used to purchase additional insurance, or applied toward premium payments, but regardless of how they are utilized, they maintain their status as a non-taxable return of premium while they remain in the policy. Tax implications may arise if dividends are left to accumulate interest or if there is a gain in the policy later on, but the dividends themselves are not taxed upon receipt.