When a policy is surrendered, the owner is entitled to at least a portion of the cash value. The actual amount that the owner receives will depend whether there are any outstanding loans or unpaid premiums that can be deducted from the cash value.The "interest build-up" portion of the annual increase in the policy's cash value is not taxed annually pursuant to the Internal Revenue Code. Dividends generally are considered to be a "return of premium" and are not taxable as long as the dividends you have received do not exceed the premiums you have paid. Although life insurance death proceeds will not typically be subject to income taxation, they may be subject to federal estate taxation. If you own part or all of the policy when you die, the value of the policy can be included in your gross estate for federal estate tax purposes. State inheritance taxes and federal gift taxes may also apply to life insurance policies/proceeds under specific circumstances. Contact your tax adviser regarding questions about possible income, estate and gift tax consequences surrounding any life insurance you own or are contemplating buying. If the policy is surrendered for its cash value only the excess of the cash value over the amount of premiums you have paid less dividends is taxable.