South Carolina Life Insurance Practice Exam

What happens to dividends from a life insurance policy for tax purposes?

1. They are considered income

2. They are taxable

3. They are not subject to income tax

4. They are subject to estate tax

The correct answer is: They are not subject to income tax

Dividends from a life insurance policy are typically considered a return of premium paid rather than income earned. As a result, they are not subject to income tax. This classification means that policyholders can receive these dividends without having to report them as taxable income on their tax returns. Dividends may be used by policyholders for various purposes, such as reducing future premiums, purchasing additional coverage, or even taking them in cash. Since these dividends are a return of funds that the insured has already paid into the policy, they do not count as taxable income. It is important to differentiate this situation from other forms of income or financial returns that may be subject to taxes. In the case of life insurance, the tax treatment of dividends is one of the advantages that policyholders enjoy, making this option the correct answer.