76 / What are the tax consequences of changing the method of receiving the proceeds of a life insurance policy?

The surviving spouse of an insured who died before October 23, 1986, is not precluded from obtaining the benefits of the $1,000 annual interest exclusion at a later date simply because the surviving spouse originally elected to leave the proceeds with the insurer under the interest-only option. A new election to take the proceeds under a life income or other installment option will entitle the surviving spouse to the annual interest exclusion.¹ During the time the proceeds are held under the interest-only option, the interest will be fully taxable to him or her as received ( Q 70). Payments under the life income or installment option will be treated as explained in Q 71 to Q 74.

Insured Died Before August 17, 1954

In tax years beginning before January 1, 1977, the full installment or life income payment was tax-free to the beneficiary except excess interest, provided the option was elected under a contract right.² Effective for tax years beginning on or after January 1, 1977, IRC Section 101(f) was repealed.³ As a result, these payments fall within the general rules (above) applicable where the insured died after August 16, 1954.