What is true about the proceeds of a life insurance policy left to earn interest with the company?

When the proceeds of a life insurance policy are left with the insurance company to earn interest, it is the interest earnings that are subject to income tax. This means that any additional funds generated from the interest accrued on those proceeds are taxable as ordinary income. The principal amount, which is the actual death benefit, is not subject to income tax when it is paid out to beneficiaries.

Understanding the distinction between the principal and the interest is critical here. The original proceeds from the life insurance policy, being a death benefit, are typically exempt from income taxes. However, once those proceeds are allowed to accumulate interest within the insurance company, that interest becomes taxable to the recipient when they eventually access it or withdraw the funds. This understanding is fundamental to financial planning and taxation matters related to life insurance policies.