What type of income do dividends from a life policy typically represent?

Dividends from a life insurance policy are considered a return of excess premium. This means that the dividends are not characterized as income in the traditional sense; instead, they represent money that has been overpaid by the policyholder based on the insurance company's financial performance and claims experience.

When a policyholder pays premiums, the insurance company invests those funds and manages risk. If the company performs better than expected, it may declare dividends to policyholders as a way of returning some of the surplus. This is essentially a way to refund parts of the premiums that were not needed to cover claims and expenses. Therefore, such dividends reduce the overall cost of insurance, rather than providing taxable income or falling into categories like ordinary income or capital gains.

This classification is essential for policyholders to understand, as it influences how they view their investments in life insurance and its impact on their overall financial planning.