Question 67

Life insurance proceeds are tax free at the time of the insured's death.

Life insurance proceeds received by the beneficiary upon the death of the insured are typically not subject to income tax, making them tax free at that time.

A) Taxed as earned income.

This option is incorrect because life insurance proceeds are not considered earned income. Earned income typically includes wages or salaries from employment, which does not apply to the proceeds from a life insurance policy.

B) Taxed as unearned income.

This option is also incorrect. While unearned income refers to income derived from sources such as interest, dividends, or capital gains, life insurance proceeds do not fall into this category and are not taxed as unearned income when received by the beneficiary.

C) Tax deferred to the estate of the insured.

This option is misleading. Life insurance proceeds are generally not deferred to the estate in a way that would impose taxes on the beneficiary. Instead, they are paid directly to the beneficiary and are typically exempt from income tax at the time of the insured's death.

D) Tax free at the time of the insured's death.

This option is correct. Life insurance proceeds are generally received tax free by the beneficiary, meaning they do not incur any income tax liabilities upon the death of the insured. This is a key feature of life insurance that provides financial relief to beneficiaries.

Conclusion

The correct answer is D because life insurance proceeds are exempt from income tax when paid to beneficiaries. Options A, B, and C incorrectly categorize the tax treatment of these proceeds, failing to recognize the tax-free status that benefits the recipient during a time of loss. Understanding this aspect of life insurance is essential for financial planning and informing beneficiaries about their rights.