South Carolina Life Insurance Practice Exam

Which type of policy requires an IRS mandated corridor between cash value and death benefit?

1. Whole Life Insurance

2. Term Life Insurance

3. Universal Life Insurance

4. Variable Life Insurance

The correct answer is: Universal Life Insurance

Universal Life Insurance requires an IRS mandated corridor between cash value and death benefit to maintain its status as a life insurance policy under the Internal Revenue Code. This corridor is designed to prevent the policy from becoming a modified endowment contract (MEC), which would have different tax implications. In a universal life insurance policy, the cash value can grow over time, and if it gets too close to the death benefit, it could lead to tax liabilities. The IRS stipulates that a minimum difference, or corridor, must exist between the cash value and the total death benefit to ensure that the product is functioning primarily as life insurance rather than an investment vehicle. Maintaining this corridor is crucial for policyholders to benefit from the tax advantages associated with life insurance. Understanding this concept is essential for navigating how different types of life insurance policies operate and their respective tax treatments, particularly for universal life insurance which combines flexible premiums and an investment component tied to the cash value.