New Jersey Life Producer Practice Exam 2026 – Your Complete All-in-One Guide to Exam Success!

Life insurance death benefits are generally not subject to federal income tax, making this the correct choice. When a policyholder passes away and the designated beneficiaries receive the payout from a life insurance policy, those proceeds are typically not included in the taxable income of the beneficiaries. This means that the beneficiaries can receive the full amount of the death benefit without incurring federal income tax obligations on that amount.

The rationale behind this tax treatment is to provide financial protection to the beneficiaries, allowing them to use the funds to cover expenses such as funeral costs, living expenses, and debts without the burden of taxes. This exemption from federal income tax is a key feature of life insurance policies, making them an attractive financial planning tool.

In contrast to this, while some states may have their own taxation rules that could potentially affect life insurance proceeds, the lack of federal income tax application for these benefits remains a foundational principle. Capital gains tax does not apply to life insurance death benefits, as the gains derived from the policy are not realized until the insured's death, which does not create a taxable event in terms of capital gains. Thus, understanding the favorable tax treatment of life insurance benefits can significantly influence decisions regarding estate planning and beneficiary designations.