What happens to the excess amount received upon cash surrender of a life insurance policy?

When a policyholder surrenders their life insurance policy for cash, the excess amount received over the total premiums paid is considered taxable income. This means that if the cash surrender value exceeds the total premiums the policyholder has paid into the policy, that excess portion is taxable as ordinary income.

In essence, the policyholder is essentially receiving a return on investment for the premiums they paid, but any amount that exceeds this investment is subject to taxation. This is designed to ensure that the tax implications reflect the growth that a policyholder may have realized through the policy's cash value accumulation.

The taxation rules indicate that only the portion of the cash surrender value that is in excess of the total premiums paid is subject to tax. Therefore, understanding this concept is vital for policyholders considering cash surrender options to manage their tax liabilities effectively.