Iris collected $150,000 on her deceased husband's life insurance policy. The policy was purchased by the husband's employer under a group policy. Iris's husband had included $5,000 in gross income from the group term life insurance premiums during the years he worked for the employer. She elected to collect the policy in 10 equal annual payments of $18,000 each.

Question

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Each $18,000 payment that Iris receives can be divided into two parts: a nontaxable return of capital (which is the portion of the payment that represents a return of her investment in the policy) and taxable income (which is the portion of the payment that represents interest or other earnings on her investment). In this case, Iris invested $5,000 in the policy (which is the total amount of premiums her husband paid that was included in gross income) and received $150,000 in proceeds. Therefore, her investment represents 5/180 of the total proceeds ($5,000/$180,000), or 2.78%. Each $18,000 payment includes a return of capital of 2.78% ($500) and taxable income of 97.22% ($17,500). Therefore, for each $18,000 payment, Iris can exclude $500 from gross income and must include $17,500 in gross income.

Iris Collected $150,000 on Her Deceased Husband's Life Insurance Policy