PSI Life Exam Practice Test

When a beneficiary receives interest payments from an insurer, how are such payments generally treated for tax purposes?

1. As ordinary income

2. As capital gains

3. As tax-exempt income

4. As investment returns

The correct answer is: As ordinary income

When a beneficiary receives interest payments from an insurer, those payments are typically treated as ordinary income for tax purposes. This classification means that the interest payments are subject to income tax at the beneficiary's applicable tax rate, similar to wages or other forms of compensation received. Interest income is earned on various forms of accounts and investments, and the IRS requires that it be declared as part of the beneficiary's taxable income during their annual tax return. This tax treatment applies regardless of the source of the interest, whether it’s derived from an insurance policy, bank savings, or bonds. Understanding this classification is critical for beneficiaries as it impacts how the received payments impact their overall tax liability. Other forms of payments, such as capital gains, tax-exempt income, or investment returns, would be subject to different tax treatments, but in the case of interest from an insurer, it is straightforwardly considered ordinary income.