If you cash in a life insurance policy, you may need to pay tax on the cash surrender value. Any amount you receive over the amount of premiums you paid is generally taxable income.
Why is a surrender of life insurance taxable when a death benefit usually isn’t?
The reason the life insurance policy holder has to pay taxes on a surrender is that you’re making an investment. When you invest your money and get a return, you have to pay taxes.
The government has made a policy decision to not tax the beneficiary of a death benefit, but this doesn’t apply to a surrender.
Calculating the Tax on the Cash Surrender Value of a Life Insurance Policy
Think of your life insurance policy like a savings account that you can withdraw money from. The amount you deposit is yours and you can take it back tax free. The interest is income and is taxed.