Arkansas Life and Health Insurance Practice Exam

When the dividends received exceed the total premium paid in for the life insurance policy, the excess dividend is considered __________.

1. Capital Gain

2. Non-Taxable Income

3. Taxable Income

4. Tax-Deferred Income

The correct answer is: Capital Gain

When dividends received from a life insurance policy exceed the total premium paid in, the excess dividend is considered a capital gain. This is because it is a profit earned on the investment in the policy, similar to the gains realized from other types of investments such as stocks or real estate. It is important to differentiate between the total premium paid in for the policy (which is the original investment) and any dividends received on top of that amount (which represent a return on that investment and are treated as capital gains). Options B, C, and D are incorrect: - Non-Taxable Income: Dividends exceeding the total premium paid are not considered non-taxable income since they represent a profit or gain from the policy. - Taxable Income: While any interest earned on the cash value of a life insurance policy may be taxable, the excess dividends received above the total premium paid are specifically categorized as capital gains. - Tax-Deferred Income: Tax-deferred income refers to income that is earned but taxes on it are deferred to a later date. Excess dividends, in this scenario, are not categorized as tax-deferred income but rather as capital gains.