Which is considered a major tax advantage of life insurance?

• A. Income tax is typically not owed on proceeds paid directly to a beneficiary
• B. Proceeds are always taxable
• C. Loans against cash value are taxable
• D. Premiums are tax-deductible

Answer: (A)

The key idea is how life insurance proceeds are taxed. When a death benefit is paid to a named beneficiary, that money is generally free from federal income tax for the recipient. This means the beneficiary receives the full amount without having to set aside or pay income taxes on it, which is a major advantage of life insurance.

There are a few nuances to keep in mind. The tax-free treatment primarily applies to the death benefit paid to a beneficiary. If the proceeds end up in the decedent’s estate, they could be subject to estate taxes, and if interest accrues on the death benefit or if the policy is transferred for value in certain situations, taxes may apply to the interest or to the could-be taxable portion. Inside the policy, cash value grows tax-deferred, but distributions from that cash value can be taxable if you withdraw more than your cost basis or take a loan that is not repaid.

Why the other options don’t fit: the death benefit is not typically taxable to the beneficiary; loans against cash value are generally not taxable as long as the policy remains in force; and premiums paid are not usually deductible for individuals (except in specific business contexts, which is not the general rule).