There are a large number of variations of life insurance policies. The "tax advantage" of life insurance occurs when a policyholder purchases a policy where a portion of the annual premium results in the build up of cash value as a result of profitable investments by the insurance company. Those investments can be paid out, typically annually, in the form of dividends which the IRS considers as not-taxble return of excess premium. Alternatively, dividends can be retained and over time come to totally pay the cost of insurance. For many types of policies where that "excess premium" results in an increase in death benefit and cash value, if no withdrawal (and not speaking of a "policy loan") is taken during the life of the insured, the increase in death benefit is not taxable. HOWEVER, if a policy owner terminates a policy in which value has increased, the IRS hold that some of that distribution is in fact investment return and taxable, while the remainder may be a return of premium, depending on terms of the policy. The one policy where the policyholder derives zero benefit of any of this is with a "term policy" in which there is only a one year, typically, to pay a death benefit and no build up of investment value. So, without knowing the type of policy which you purchased and given the obvious fact that you are still alive ... seems like your "early" termination of the policy makes the proceeds taxable.
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