Life & Health Insurance Exam (National Portion)Taxes, Retirement, and Other Insurance ConceptsEasy
A life insurance policy was purchased 10 years ago with a face amount of $200,000 and a total premium paid of $15,000. The insured recently passed away, and the beneficiary received the $200,000 death benefit. How is this death benefit treated for federal income tax purposes?
- AThe $200,000 death benefit is partially taxable, only the amount exceeding premiums paid.
- BThe $200,000 death benefit is fully taxable as ordinary income.
- CThe $200,000 death benefit is subject to capital gains tax.
- DThe $200,000 death benefit is generally received income tax-free.
Show answer & explanationAnswer & explanation
Correct answer: D. The $200,000 death benefit is generally received income tax-free.
Death benefits from life insurance policies are generally received by the beneficiary free from federal income tax, regardless of the amount or premiums paid.
Why the other options are wrong
- A. The 'cost basis' rule applies to living benefits (like cash value surrender), not death benefits.
- B. Life insurance death benefits are typically not considered ordinary income to the beneficiary.
- C. Death benefits are not treated as capital gains.
Life Insurance Death Benefit Taxation
The death benefit paid to a beneficiary from a life insurance policy is generally exempt from federal income tax.
- Applies to all types of life insurance (term, whole, universal).
- Income tax-free to the beneficiary.
- May be included in the deceased's estate for estate tax purposes, but not income tax for the beneficiary.
Memory trick: Death benefits are a 'Tax-Free Gift' to the beneficiary.