Gain on surrender is the taxable amount realized when a policy or annuity is surrendered for cash: generally the cash value received minus the owner's investment in the contract (total premiums paid less prior non-taxable withdrawals). For non-MEC life insurance, withdrawals are basis-first before surrender; for MECs and annuities,distributions are gain-first. Ordinary income tax applies to gain; surrender charges may reduce proceeds but not taxable income. Accurate basis records and timing considerations help minimize unexpected tax upon surrender or exchange into a new contract under 1035.

Advisors calculate basis before surrender and compare 1035 exchanges to avoid unnecessary tax. They time surrender to cash-flow needs and warn that surrender charges do not reduce taxable gain. Clear records prevent surprises at tax time.