To maximize the power of Internal Revenue Code (IRC) Section 7702 many producers wonder what is the best way to structure a life insurance policy if given the choice of using either the Cash Value Accumulation Test (CVAT) or the Guideline Premium Test (GPT). For this reason, making the proper choice -- or selecting a product with the specific test more favorable to the plan design -- is an important issue when structuring the policy. The test selected can have a significant impact on premiums, cash values and death benefits.
The basic difference between these two tests is that CVAT limits the cash value relative to the death benefit, while GPT limits premiums paid relative to the death benefit. If an insurance policy fails either of these tests, then it is not considered a life insurance policy and all income tax benefits are eliminated.
GPT has two components: a premium limit component, and a corridor component. The premium limit restricts the amount of premium that can be paid into the policy. The corridor requires that the life insurance benefit be at least a certain percentage of the policy value.
Generally You May Want To Use GPT When:
You are paying maximum premiums beyond the 7-pay period
You want to create large cash values and maximize policy distributions at the expense of the policy death benefit
You start with death benefit option 2 and wish to pay the maximum non-MEC premium for more than 7 years, before switching to death benefit option 1
The corridor under CVAT is different than the corridor under GPT. Specifically, the CVAT corridor requires more life insurance benefit in relation to policy value. Therefore, as your client's policy values increase, the life insurance benefit will increase more rapidly under CVAT than under GPT due to the corridor differences. With CVAT, the higher death benefit results in a higher Cost of Insurance (COI), which can lower policy value and the death benefit corridor over time. The end result is that GPT policies may have higher policy values and lower corridor death benefits in later durations. The difference in corridor between the two tests decreases as the issue age increases.
Generally you may want to use CVAT when:
- You are writing a MEC contract with a goal to maximize the long-term death benefit
- Your primary objective is to max-fund a life insurance policy, yet provide the greatest long-term death benefit.
- You want to highly fund a policy (in excess of the GPT limits) over a short period of time
Before you run your next illustration, be sure to understand the client's needs so you can choose the right test.
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