Tennessee Insurance Practice Exam

A policy owner may generate taxable income from which of the following dividend options?

1. Paid-up insurance

2. Cash payment

3. Accumulation at interest

4. Reduction of premium

The correct answer is: Accumulation at interest

When a policy owner chooses the accumulation at interest option for dividends, any interest earned on the accumulated dividends is considered taxable income. The Internal Revenue Service (IRS) treats this interest as ordinary income, meaning the policyholder must report it on their tax return. In contrast, other options such as paid-up insurance, cash payment, and reduction of premium typically do not generate taxable income. The cash payment option is not taxable up to the amount of the original investment in the policy, while using dividends for paid-up insurance or reducing future premiums does not create taxable income. Therefore, accumulation at interest stands out as the option that has potential tax implications for the policy owner.