Death benefits paid to beneficiaries are typically income-tax-free.

• A. Income-tax-free
• B. Taxable as ordinary income
• C. Taxed as capital gains
• D. Subject to estate tax only

Answer: (A)

Death benefits are typically income-tax-free because the tax law excludes life insurance proceeds paid to a named beneficiary from the recipient’s gross income. In other words, receiving a death benefit does not count as ordinary income or capital gains for the beneficiary under the standard rule. The proceeds are generally not taxable income to the recipient.

There are edge cases to be aware of. If the policy’s ownership or the way benefits are paid creates interest cash flow, that interest portion can be taxable, and if the policy proceeds are treated as part of the decedent’s estate (for estate tax purposes), they could be subject to estate tax. But the core point for most death-benefit payouts is that they are not taxed as income to the beneficiary.