If a beneficiary receives death benefits that include principal and interest, which part is taxable?

In the context of death benefits received from a life insurance policy, the taxation rules specify that only the interest component is taxable when a beneficiary receives both principal and interest. The principal refers to the death benefit amount that the policyholder designated to be paid to the beneficiary upon death; this amount is not subject to income tax. This non-taxable nature of the principal is a key feature of life insurance benefits, as they are designed to provide financial support without imposing a tax burden on the beneficiary at the time of the policyholder's death.

However, any interest accrued on the life insurance death benefit after the policyholder's death is considered taxable income. This interest is generated while the insurance company holds the funds before they are distributed to the beneficiary or if the payments are made over time. Therefore, the part that is taxable is specifically the interest, making it essential for beneficiaries to understand their potential tax liability regarding these funds.