What happens to cash value above the accumulated premiums if a policy is surrendered?

When a policy is surrendered and there is cash value above the accumulated premiums, that excess is subject to taxation. This is because the tax treatment of cash value in life insurance is designed to treat the portion that exceeds the sum of premiums paid as taxable income. During the term of the policy, the cash value accumulation is typically tax-deferred, but upon surrendering the policy, the IRS will require that any gains—defined as the excess cash value over your total investment or premiums paid—be reported and taxed as ordinary income. This is a fundamental principle of life insurance taxation, reflecting the notion that taxpayers should pay tax on the gains they receive.

It's important to understand the nuances regarding accumulated premiums and cash value, as these will significantly affect financial planning strategies by policyholders when considering surrendering their life insurance policies.