Do I have to pay a 10% early withdrawal penalty on the surrender of a variable universal life insurance policy?

[dreilly85]

I had been paying monthly premium payments to the Variable Universal Life (VUL) policy for years.  I dedided to shift to term life insurance, so I surrendered the policy and withdrew the cash value.  I understand that the excess income is taxable (my amount is about $5000) and I had tax withheld.  My problem is that I was not expecting a 10% early withdrawal penalty on this transaction since it is not a retirement account or annuity.

[dmertz]

If the code in box 7 includes a code 1, the insurance company is apparently treating the policy as a modified endowment contract, making the taxable portion subject to the 10% early-distribution penalty.