A policyowner takes a $30,000 partial surrender from their whole life policy. Their cost basis (premiums paid minus dividends) is $45,000 and the total cash value is $80,000. How is this partial surrender taxed?

TAXATION OF PARTIAL SURRENDERS from non-MEC life insurance policies uses FIFO (First In, First Out) accounting — the policyholder's own cost basis is considered to come out first, before any gain.

Calculation: Basis = $45,000 (premiums paid minus any dividends received on a tax-free basis); Cash value = $80,000; Total gain = $80,000 − $45,000 = $35,000; Partial surrender = $30,000.

FIFO result: The first $45,000 of withdrawals are tax-free (return of basis); the remaining gain ($35,000) would be taxable only after all basis is recovered; since $30,000 < $45,000 basis, NO TAX is owed on this withdrawal.

Contrast with mec policies: MECs use LIFO — gain comes out first; the same $30,000 withdrawal from a MEC with $35,000 of gain would result in $30,000 being taxable PLUS the 10% penalty if under age 59½.

Contrast with annuities: Annuities also use LIFO — gain comes out first.

Contrast with policy loans: Policy loans from non-MEC policies are NOT taxable as long as the policy remains in force (loans are not income, they are debt); if the policy lapses with an outstanding loan exceeding the basis, the gain is taxable in the lapse year.

Practical implication: For clients who need to access cash value, partial surrenders from non-MEC policies are very tax-efficient as long as withdrawals stay within the cost basis.