What may be subject to taxation when a policyowner cancels a universal life policy?

When a policyowner cancels a universal life policy, the amount that may be subject to taxation is typically the withdrawals from the policy's cash value that exceed the total premiums paid into the policy. This is because, under federal tax law, policyholders are able to withdraw up to the amount of their premiums without facing any tax liability, as this amount represents their cost basis in the policy.

Once the policyowner withdraws amounts beyond what they have paid, that excess is considered taxable income. This taxation occurs because those amounts are viewed as gains from the investment component of the universal life policy—the difference between what they paid in and what they are taking out.

While the death benefit is typically not subject to income tax for the beneficiaries as long as it is received as a lump sum upon the insured's death, it does not apply in the context of cancellation. The entire cash value is not directly taxed when canceling a policy, but the gains from that cash value may be taxable as explained previously. Surrender charges are fees deducted by the insurer when a policy is canceled and do not directly impact the tax implications of any cash value withdrawals. Therefore, the focus is on withdrawals exceeding the premiums paid, which can create a taxable event for the policyowner when