How are life insurance death benefits typically taxed when paid to a named beneficiary?

Life insurance death benefits paid to a named beneficiary are generally received income tax-free under federal tax law. This is one of the major tax advantages of life insurance. The income tax exclusion applies to the lump-sum death benefit; if the beneficiary chooses to take the proceeds in installments with interest, the interest portion is taxable. Federal estate tax can apply if the deceased's total estate exceeds the federal exemption ($13 million+ per individual in 2024, indexed for inflation), and if the deceased was the owner of the policy at death or transferred ownership within three years. To avoid estate tax, large policies are often owned by an irrevocable life insurance trust (ILIT). State inheritance taxes vary.