Life Insurance✓ Verified · outline & fact-checked · Sep 2026Difficulty 2/5
A beneficiary elects to receive a $200,000 life insurance death benefit in 20 equal annual installments rather than a lump sum. Under the general rule, the beneficiary:
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
The death benefit paid as a lump sum is generally income tax free under IRC Section 101(a). When proceeds are paid in installments, the principal amount (the death benefit) is still tax free, but the interest earned on the unpaid proceeds is taxable as ordinary income. Each installment therefore contains a tax-free return of principal and a taxable interest element.
Why the other options are wrong
- B) The principal portion is a tax-free return of the death benefit; only the interest component is taxed.
- C) While the lump sum is tax free, the interest earned under the installment option is taxable; no installment plan avoids tax on interest.
- D) There is no 10% penalty on installment payment of death benefits; penalties apply to certain early annuity distributions under IRC Section 72(q).
Memory hook
Lump sum: tax free. Installments: principal free, but the interest the insurer pays you is taxable.