Colorado Life Producer License Practice Test

What does a beneficiary receive when opting for a lump sum payout from a policy?

1. Principal amount only

2. Taxable dividends

3. All payments are tax-free

4. Reduced benefits over time

The correct answer is: All payments are tax-free

When a beneficiary chooses a lump sum payout from a life insurance policy, they receive the entire death benefit in one payment. This amount is typically considered tax-free under federal tax laws, which is why the correct response states that all payments are tax-free. This aspect of life insurance payouts is a significant advantage, as beneficiaries do not have to worry about tax liabilities on the death benefit received from the policyholder's insurance. Other options are less applicable in the context of a lump-sum payout. Choosing only the principal amount or having to deal with taxable dividends does not accurately reflect the nature of life insurance payouts, which are generally structured to provide a tax-free benefit to beneficiaries, enhancing their financial security. Additionally, the idea of reduced benefits over time does not align with how lump sum benefits are issued, as the full amount is delivered at once rather than over an extended period.