Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

Are life insurance death benefits typically subject to taxation?

1. Yes, they are fully taxable

2. Yes, but only a portion is taxable

3. No, they are received tax-free

4. Depends on the policy type

The correct answer is: No, they are received tax-free

Life insurance death benefits are generally received tax-free by the beneficiaries. This tax-free characteristic is a fundamental aspect of life insurance policies, making them an attractive financial tool for individuals looking to provide for their loved ones upon their death. The Internal Revenue Code stipulates that the proceeds from a life insurance policy paid to a beneficiary due to the death of the insured are not included in the taxable income of the beneficiary. This provision helps ensure that the full amount of the death benefit can be utilized by the beneficiaries without any tax implications, allowing for financial support during a potentially challenging time. There are exceptions to tax-free treatment, such as in cases where the death benefit is paid out as part of a financial arrangement or if the policyholder has certain loans against the policy, but these are typically more complex situations. In general practice, beneficiaries can expect to receive life insurance proceeds free of federal income tax. Therefore, the premise that life insurance death benefits are received tax-free is well-supported and aligns with the intent and design of life insurance as a financial strategy for providing security to loved ones.