Guideline Premium And Corridor Test (GPT)

The Guideline Premium And Corridor Test (GPT) test is used to determine whether an insurance product can be taxed as insurance rather than as an investment. GPT limits the amount of premiums that can be paid into an insurance policy relative to the policy’s death benefit.

Being able to pass the guided premium and corridor test is incredibly important to a policyholder as well as the insurer. If an insurance product fails to pass the test, it is no longer considered an insurance product, and is thus taxed like an investment. Insurance policies are able to grow in value on a tax-deferred basis, with death benefits being exempt from income tax. Most other investments are taxed as ordinary income, meaning that failing to pass the test will lead to a higher tax rate.

The GPT method is used when the policyholder wants to pay the maximum amount of premiums while maintaining a variable death benefit, or wants to maximize the amount of cash that he or she can accumulate in the policy more so than he or she is interested in maximizing the death benefit. Rather than focusing on the death benefit available at life expectancy, the GPT is used when the policyholder wants to maximize benefits at a much later age (such as 100).

In addition to the guided premium and corridor test, an insurer has the option of designing a policy so that it passes the cash value accumulation test, or CVAT. The CVAT limits the cash value relative to the death benefit, unlike the GPT, which limits the premiums relative to the death benefit.

The insurer must indicate which test is going to be used on the issue date, and once the policy is issued the insurer cannot decide to use the other test option instead. The choice of test can determine what the policy premiums, cash value, and benefits will be.

In the early 1980s, new universal life insurance products started being regarded as investment vehicles — with cash surrender values — rather than traditional definitions of life insurance. The federal government stepped in to remedy this evolving situation with the Deficit Reduction Act of 1984 (DEFRA).

DEFRA established qualifications that universal life policies must meet in order to maintain advantaged tax status under the Internal Revenue Code (IRC) Section 7702. To fulfill the IRC definition of life insurance, life insurance contracts must provide for a sufficient “amount at risk” — the pure death benefit protection that a beneficiary would receive upon the death of the insured. In other words, the face value minus the built-up cash value.