How are dividends received by a policy owner treated in relation to income tax?

Dividends received by a policy owner from a life insurance policy are generally considered to be a return of premiums that have been paid into the policy. As such, these dividends are not treated as taxable income, making them completely tax-free to the recipient. However, if there are interest earnings on those dividends while they are left to accumulate within the policy, that interest does indeed become taxable as ordinary income.

This means that the primary amount of the dividends received is not taxed, but any interest generated from the accumulation of those dividends is subject to taxation. It’s essential for policy owners to understand this distinction for proper tax reporting and financial planning. The aspect of taxable interest on accumulations plays a crucial role in how dividends impact an individual's tax situation.