PSI Ohio Insurance Practice Exam

Which statement about federal taxation of life insurance premiums is true?

1. Premiums are fully tax-deductible.

2. Premiums are not tax-deductible and paid with after-tax dollars.

3. Premiums are exempt from income tax only.

4. Premiums are only partially deductible.

The correct answer is: Premiums are not tax-deductible and paid with after-tax dollars.

The statement that premiums are not tax-deductible and paid with after-tax dollars is accurate. In the context of federal taxation in the United States, the premiums paid for personal life insurance policies are considered personal expenses. Therefore, they are not deductible from taxable income. This means the premiums must be paid with income that has already been taxed. This understanding is essential for individuals considering life insurance as part of their financial planning. Moreover, recognizing that premiums are not tax-deductible helps clarify the potential future tax implications associated with the death benefit. Typically, the death benefit received by beneficiaries is income-tax-free, which further highlights the favorable tax treatment concerning the proceeds of life insurance compared to the treatment of the premiums themselves. This distinction is important for policyholders to understand, as it influences their budgeting and expectation regarding tax liability related to their insurance investments.