A Guide to TEFRA, DEFRA, and TAMRA in Life Insurance

TEFRA, DEFRA, and TAMRA in Life Insurance

Understanding the Tax Impacts

When it comes to life insurance, grasping the tax implications is essential for getting the most out of your policy and ensuring long-term financial security. The Tax Equity and Fiscal Responsibility Act (TEFRA), the Deficit Reduction Act (DEFRA), and the Technical and Miscellaneous Revenue Act (TAMRA) are three pivotal legislative acts that shape the tax treatment of life insurance policies.

TEFRA: Establishing Tax-Deferred Growth

Passed in 1982, TEFRA set the foundation for tax-deferred growth in life insurance policies. This allows policyholders to benefit from compound growth without facing immediate tax consequences, making it a powerful tool for long-term financial planning.

This act established guidelines to determine the maximum amount of premium that may be paid into a flexible premium policy and the minimum death benefit that must be provided in order to qualify for tax-deferred income on cash values, income tax-free death benefits, and other life insurance tax benefits.

DEFRA: Focusing on Premium Efficiency

Following TEFRA, DEFRA (enacted in 1984) emphasizes the importance of managing premium payments efficiently. This legislation affects policy loans and ensures that policyholders continue to receive favorable tax treatment on their policies.

Lawmakers believed it was important to differentiate between life insurance policies that were being used as traditional insurance or as investment vehicles, so they established the guideline premium and corridor test within the Deficit Reduction Act of 1984 (DEFRA).2

U.S Congress, the Joint Committee on Taxation. “Tax Treatment of Single Premium and Other Investment-Oriented Life Insurance,” Pages 6-7.

DEFRA established the qualifications that universal life insurance policies must meet to maintain advantaged tax status under the Internal Revenue Code (IRC) Section 7702.1 To fulfill the IRC definition of life insurance, life insurance contracts must provide for a sufficient “amount at risk”, meaning that the pure death benefit protection that a beneficiary would receive upon the death of the insured is adequate (Investopedia, 2023)

TAMRA: Preserving Long-Term Tax Advantages

The Technical and Miscellaneous Revenue Act of 1988 (TAMRA) established the 7-Pay Test, which limits the amount of money that can be paid into a life insurance policy within the first seven years: 

What is the 7-Pay Test?

The 7-Pay Test is a calculation that determines if a life insurance policy is a Modified Endowment Contract (MEC): 

1. Calculate the total amount of premiums needed to pay up the policy 

2. Divide that amount by 7 

3. If the policyholder pays more than that amount each year, the policy fails the test and becomes an MEC 

   
   

What is a Modified Endowment Contract (MEC)?

A MEC is a life insurance policy that has failed the 7-Pay Test: 

• MECs have different tax treatment than traditional life insurance policies 

• The cash value in an MEC accumulates tax-free, but withdrawals and loans are taxable 

• Borrowing money from an MEC can reduce the death benefit for heirs 

• Once a policy becomes an MEC, it can't be changed back to a non-MEC policy 

How to avoid becoming an MEC?

To avoid becoming an MEC, you can ask your insurance agent or carrier about their policy for handling excess premiums. Insurance carriers will notify policy owners if the 7-Pay Test or IRS guideline premiums are exceeded.

What This Means for You

For those with life insurance policies, understanding these laws is key to maximizing the tax benefits. TEFRA, DEFRA, and TAMRA create a tax-friendly environment that allows policyholders to grow and protect their wealth through their life insurance policies over time.

How King Legacy Group Can Help

Life insurance policies are legal contracts between the policyholder and the insurer, but the nuances of tax laws like TEFRA, DEFRA, and TAMRA can be complex. The experienced advisors at King Legacy Group are here to help you navigate these rules, ensuring you fully understand the benefits and make the most of your life insurance investment. We’ll guide you through each step, so you can leverage these tax laws to secure your financial future.

Conclusion

TEFRA, DEFRA, and TAMRA are key pillars in the life insurance landscape, providing significant tax advantages for policyholders. At King Legacy Group, our experts are equipped to help you navigate these important regulations and make informed decisions about your life insurance strategy. We’re committed to helping you grow and protect your wealth through well-planned life insurance policies.

Be sure to stay connected with us for regular updates, industry insights, and exclusive offers. At King Legacy Group, we’re here to be your trusted partner in achieving financial security through smart life insurance planning.