Which statement about death benefits and cash value growth is accurate?

• A. Death benefits are tax-free; cash value growth is tax-deferred.
• B. Death benefits are taxable; cash value growth is tax-deferred.
• C. Death benefits are tax-free; cash value growth is tax-free.
• D. Death benefits are taxable; cash value growth is tax-free.

Answer: (A)

When you look at how life insurance is taxed, two ideas stand out. First, the death benefit paid to beneficiaries is generally free from federal income tax. That means the beneficiary receives the payout without having to report it as taxable income. Second, the cash value that builds inside the policy grows without current taxation—the growth is tax-deferred while it remains inside the policy. So the standard, widely tested idea is that death benefits are tax-free to the beneficiary, while cash value growth is tax-deferred. (Note: accessing the cash value via withdrawals or loans can have tax consequences in certain situations, especially with modified endowments or amounts above the basis, but the basic rule described holds for a typical policy.)