75 / Is a surviving spouse entitled to an additional exclusion for interest on death proceeds paid out via a life income or installment option upon the spouse’s death?

In addition to the prorated exclusion of principal (see Q 71 to Q 74), the surviving spouse of an insured who died prior to October 23, 1986, is entitled to exclude from gross income up to $1,000 of interest (guaranteed and excess) in each taxable year. (The surviving spouse’s $1,000 annual exclusion was repealed for surviving spouses of insureds who die after October 22, 1986.) No more than $1,000 of interest may be excluded annually with respect to one insured, regardless of the number of policies. But if the beneficiary is the surviving spouse of more than one insured, the beneficiary is entitled to a $1,000 annual interest exclusion with respect to policies on the life of each insured.¹ To qualify for this additional exclusion, the surviving spouse must have been married to the insured when the insured died. An absolute divorce disqualifies the beneficiary, although a legal separation or an interlocutory decree does not.² The surviving spouse’s remarriage does not affect his or her qualification.³ This $1,000 annual exclusion is available only with respect to the interest element in life income or installment payments; it is not available with respect to interest payments under an interest-only option. In other words, the settlement must provide for a substantial diminution of principal during the period the interest is received.⁴ It would appear that because payments of proceeds (including interest) from National Service Life Insurance (NSLI) otherwise are exempted from taxation, the receipt of NSLI proceeds under an installment settlement will not reduce the $1,000 annual exclusion ( Q 139).

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1.     IRC § 101(d)(1)(B), prior to repeal by TRA ’86 § 1001(a); Treas. Reg. § 1.101-4(a)(2), Ex. 2.

2.     Treas. Reg. § 1.101-4(a)(1)(ii); see Eccles v. Commissioner, 19 TC 1049 (1953), aff’d, 208 F.2d 796 (4th Cir. 1953).

3.     Rev. Rul. 72-164, 1972-1 CB 28.