What is the general tax treatment of life insurance proceeds paid as a death benefit to beneficiaries?

• A. Taxable as ordinary income to beneficiary
• B. Tax-free to beneficiary
• C. Taxed as estate income
• D. Taxed as capital gains

Answer: (B)

When a life insurance policy pays out a death benefit to a named beneficiary, the payout is generally received income-tax-free by the beneficiary. The death benefit is excluded from gross income, so the beneficiary does not report the lump-sum as ordinary income. If the payment is made with interest because the payout is delayed, the interest portion is taxable as ordinary income to the beneficiary. In addition, the death benefit typically isn’t included in the insured’s estate for federal estate tax purposes, unless the insured retained incidents of ownership in the policy at death.