Under what condition is a death benefit from an accidental death and dismemberment policy taxable?

The correct condition under which a death benefit from an accidental death and dismemberment policy is taxable is when it is paid out in installments. Generally, life insurance death benefits are not taxable; however, if the benefit is structured as an installment payment rather than a lump sum, the interest earned on those installment payments may be subject to income tax.

When benefits are distributed in a lump sum, they are typically not subject to income tax. However, when beneficiaries choose or are required to receive the benefits in installments, any interest accrued on the principal amount during that period is taxable as income. Thus, while the principal amount remains tax-free, the additional interest earned can create tax obligations, leading to tax implications for the recipient.

It’s important to understand the nuances of how benefits are received because the method of payment can determine tax liability. In the case of immediate lump-sum payments, the entire amount is usually tax-exempt. In contrast, ongoing payments that include interest lead to potential taxation on that interest portion.