California Life-Only & Accident and Health AgentLife InsuranceMedium
A life insurance policyowner dies and the death benefit is paid to the beneficiary. For federal income tax purposes, how is the death benefit generally treated?
- AIt is generally received income tax-free by the beneficiary.
- BIt is taxable as a capital gain to the beneficiary.
- CIt is taxable as a dividend to the beneficiary.
- DIt is taxable as ordinary income to the beneficiary.
Show answer & explanationAnswer & explanation
Correct answer: A. It is generally received income tax-free by the beneficiary.
Under current federal tax law, life insurance death benefits paid to a named beneficiary are generally received income tax-free. This is a fundamental tax advantage of life insurance.
Why the other options are wrong
- B. Death benefits are generally not treated as capital gains.
- C. Dividends are a different concept related to participating policies and are generally not taxed as income unless they exceed premiums paid.
- D. Death benefits are typically not considered ordinary income.
Taxation of Life Insurance Death Benefits
The federal income tax treatment of the death benefit proceeds from a life insurance policy paid to a beneficiary.
- Generally received income tax-free by the beneficiary.
- May be subject to estate taxes if the insured owned the policy at death and the estate exceeds federal limits.
- Interest earned on retained proceeds (e.g., in an Interest Only option) is taxable.
Memory trick: Death Benefit is FREE, Cash Value GROWS, Loans are SAFE.