The proceeds from life insurance are not taxed
as income to the beneficiary. However, if the insurance proceeds are left
with an insurance company to earn interest, that interest is taxable as
income. If proceeds are taken in installment payments, the portion of each
payment attributable to the basic death benefit is tax-free, but the portion
attributable to interest earned on the proceeds is taxable.
Participating
(versus nonparticipating)
insurance companies pay dividends on both term and whole life policies. A dividend is not,
as the name implies, an earned return on an investment; it is actually a
return of an overpayment on the premium paid. For this reason, dividends
are not taxable.