Washington Life Producer Practice Exam

What is a major tax advantage of life insurance?

1. Income tax is typically not owed on proceeds paid directly to a beneficiary

2. Premiums are tax-deductible

3. Cash value accumulates tax-free

4. Death benefits are taxable income

The correct answer is: Income tax is typically not owed on proceeds paid directly to a beneficiary

A major tax advantage of life insurance is that income tax is typically not owed on proceeds paid directly to a beneficiary. When a life insurance policyholder passes away, the death benefit that is paid out to the designated beneficiaries usually does not incur income tax. This means that the beneficiaries receive the full amount of the death benefit without having to pay taxes on it, making life insurance an attractive option for individuals looking to provide financial support to their loved ones after their death. This tax treatment is significant because it ensures that the full value of the policy can be used by the beneficiaries for expenses such as paying off debts, replacing lost income, or funding education. The tax-free nature of life insurance proceeds helps in wealth transfer and can be an essential part of financial planning. Other options presented do not offer the same clear tax advantage. For example, while cash value accumulation within a life insurance policy may be tax-deferred, it can be subject to taxes if it is withdrawn or if the policy is surrendered. Additionally, premiums for most types of life insurance are not tax-deductible for the policyholder, and the assertion that death benefits are taxable income is incorrect, as this goes against the primary advantage of life insurance in wealth transfer planning.