Corridor factor

[ActuaryFromMTL]

Hi all,

What is the reasoning behind the corridor factor?

I know that it's a way for the government to make UL products more insurance products rather than investments products and to prevent people from abusing this product to not pay taxes.

But can someone give me a clear example of how a person might use this product to not pay taxes? and how the corridor factor prevents them from doing it?

Thanks.

[Chuck]

Death benefits are paid tax-free from life insurance.

The tax law (IRC 7702) defines these corridors as one element in the definition of how contracts must qualify as life insurance in order to continue the tax benefit.

[Academic Actuary]

When universal life products first appeared they could be constructed to have a small amount of pure insurance with a large savings element which would accrue tax free and as mentioned paid out without taxation if paid as a death benefit. These were effectively tax sheltered savings products rather than insurance.

[ActuaryFromMTL]

Oh I think I understand now.

So, let's say I purchase a small UL insurance policy of $10,000 and I want to avoid paying taxes. All I have to do is pay way more than the minimum premium required by the UL policy (let's say $15,000 every year) and grow my AV that way (and with interest) and at some point in the future take my money out without paying any taxes.

The corridor factor prevents me from doing that.

Am I right?

[Abraham Weishaus]

Actually you have to die to avoid taxes altogether. If you take your money out while alive by surrendering, you'll have to pay tax on the excess of proceeds over premiums at that time. Still, you got the insurance tax free and you deferred taxes on the gain.

The corridor factor limits the amount of tax you can defer.

[SirActSci]

Awesome, I like these practical explanations.

[ThereIsNoSpoon]

Originally Posted by Abraham Weishaus

Actually you have to die to avoid taxes altogether.

Now that's a whole new level of avoiding taxes!

[Chuck]

Originally Posted by ThereIsNoSpoon

Now that's a whole new level of avoiding taxes!

When you think about it, we have a great new slogan for the life industry...

We Change the Certainty of Death AND Taxes to Death OR Taxes.