70 / If life insurance death proceeds are left on deposit with the insurance company under an interest-only option, is the interest taxable income to the beneficiary?

Yes. All amounts paid or credited to a beneficiary as interest (excess and guaranteed) must be included in the beneficiary’s gross income regardless of whether the insured or the beneficiary elected the option.¹ The interest is taxable in the first year that it can be withdrawn. If the beneficiary elects an option under which there is no right to withdraw either principal or interest for a specified number of years, the entire amount of accumulated interest is taxable in the year during which it first becomes withdrawable.² But if the beneficiary has a right to withdraw principal, the interest is taxable when credited even though the agreement stipulates that the interest cannot be withdrawn.³

The principal amount held by the insurer, representing the value of the proceeds at the insured’s death, is income tax-free to the recipient when withdrawn ( Q 63).

For a discussion of the tax treatment when proceeds are held for a period under the interest option and subsequently paid under a life income or installment settlement, see Q 71.