Advanced Diploma of Financial Planning (ADFP) Practice Test

Are life insurance death proceeds generally taxable as income?

1. Yes, they are fully taxable.

2. No, they are generally non-taxable.

3. Only partial amounts are taxable.

4. They are taxed at a lower rate.

The correct answer is: No, they are generally non-taxable.

Life insurance death proceeds are generally non-taxable. When a life insurance policy pays out a death benefit to the beneficiaries, those proceeds are typically exempt from federal income tax. This tax treatment applies under most circumstances, providing a significant financial advantage for the recipients, allowing them to receive the full benefit of the policy without the burden of income tax. The federal tax code specifically states that death benefits paid out by life insurance policies are excluded from taxable income. This means that beneficiaries can use the funds for any purpose—such as covering living expenses, paying off debts, or funding education—without having to worry about tax implications on the received amount. This non-taxable status of life insurance proceeds is an important consideration in financial planning and estate planning, as it helps individuals ensure that their loved ones are financially protected after their death without additional tax liabilities complicating the situation.