Beneficiaries✓ Verified · outline & fact-checked · Sep 2026Difficulty 2/5
A beneficiary elects to leave death proceeds with the insurer under an interest-only option and receives periodic interest payments. The interest payments are:
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
While the principal amount of life insurance proceeds is income-tax-free under IRC Section 101(a), any interest earned on proceeds retained by the insurer is taxable as ordinary income to the recipient. This applies to interest-only settlements and to the interest component of installment payments. The tax-free character attaches to the death benefit itself, not to earnings generated after death. Beneficiaries who receive interest or installment payments must report the interest portion on their income tax returns.
Why the other options are wrong
- B) The tax-free status attaches to the death benefit, not to the earnings generated on the proceeds after the insured's death.
- C) The interest is taxable as it is received, regardless of when the principal is ultimately distributed.
- D) Interest is ordinary income, not capital gain. Capital gain arises from the sale of capital assets, not from interest.
Memory hook
Principal is tax-free; interest earned on it is tax-filing fodder.