Texas General Lines — Life, Accident, Health and HMOGeneral InsuranceHard
A life insurance policyowner dies, and the beneficiary receives the death benefit. The policyowner had paid a total of $50,000 in premiums over the life of the policy, and the death benefit was $250,000. For federal income tax purposes, how is the death benefit generally treated?
- ATaxable only on the amount exceeding the premiums paid.
- BTaxable as a capital gain.
- CFully taxable as ordinary income.
- DGenerally received income tax-free by the beneficiary.
Show answer & explanationAnswer & explanation
Correct answer: D. Generally received income tax-free by the beneficiary.
Under current federal tax law, the death benefit proceeds of a life insurance policy are generally received by the beneficiary income tax-free. This is a significant advantage of life insurance.
Why the other options are wrong
- A. This describes the taxation of cash value withdrawals or surrenders that exceed the cost basis, not death benefits.
- B. Death benefits are not treated as capital gains, which apply to profits from the sale of assets.
- C. Death benefits are typically not considered ordinary income for the beneficiary.
Taxation of Life Insurance Death Benefits
For federal income tax purposes, life insurance death benefits are generally received by the beneficiary income tax-free.
- Income tax-free for beneficiary
- Not included in gross income
- May be subject to estate taxes if the estate is very large and owns the policy
- Different from taxation of cash value growth or withdrawals
Memory trick: Death Benefit: Your 'Death' is their 'Tax-Free' gift.