Colorado Life Producer License Practice Test

Is the interest credited under the accumulation at interest option of an insurance policy taxable?

1. Yes, it is always taxable

2. No, it is tax-free

3. Only if the policyholder receives it

4. It is taxable when it is paid out

The correct answer is: Only if the policyholder receives it

The accumulation at interest option within an insurance policy allows the policyholder to earn interest on the cash value of the policy. The interest that accrues under this option is not taxable until the policyholder actually receives it, making it tax-deferred during the accumulation period. This means that while the funds are growing inside the policy, they do not incur any tax liability. Once the policyholder chooses to withdraw or take the interest, it then becomes taxable as ordinary income. This approach to taxation incentivizes policyholders to let their investments grow without the immediate burden of taxes, promoting long-term financial planning. Therefore, interest credited under this option remains tax-free until the policyholder decides to actualize those gains through a withdrawal or distribution.