Rhode Island Life Insurance Practice Exam

Which dividend option may generate taxable income for a policyowner?

1. Cash dividends

2. Accumulation at interest

3. Paid-up additional insurance

4. Reduction of premium

The correct answer is: Accumulation at interest

The option that may generate taxable income for a policyowner is accumulation at interest. When dividends are left with the insurance company to accumulate interest, the interest earned becomes taxable, as it is considered income. This is in contrast to other dividend options that typically do not create a taxable event upon receipt. For instance, cash dividends can be taken as cash payments, which are not taxable to the extent that they do not exceed the policyowner's basis in the policy. Paid-up additional insurance increases the death benefit and does not trigger tax liability. Similarly, reduction of premium simply allows the policyowner to use dividends to offset premium payments, and this does not result in taxable income. Therefore, accumulation of interest on dividends can lead to taxable income, making it essential for policyholders to understand the implications of choosing this option.