4090 / How is a death benefit under a tax sheltered annuity taxed to an employee’s beneficiary?

A death benefit under a tax sheltered annuity generally is taxed in the same way as a death benefit under a qualified pension, qualified plan or profit sharing plan ( Q 3974 to Q 3976).

In the case of a single sum payment where no life insurance is involved, all amounts received by a beneficiary are taxable as ordinary income except that the beneficiary may exclude from gross income the employee’s unrecovered cost basis, if any.

If a death benefit consists of life insurance proceeds, the amount of the proceeds in excess of the cash surrender value of the policy immediately before the insured’s death is excludable from gross income under IRC Section 101(a)(1). For the rule under the final regulations restricting the availability of life insurance in 403(b) arrangements, see Q 4034.