Indexed universal life (IUL) is a unique financial instrument with a number of important potential tax advantages including income tax-free death benefits, income tax-deferred growth of policy cash values, and income tax-free access to cash values through policy loans and/or withdrawals. The ability to take advantage of these tax-free benefits is largely governed by the following tax laws: TEFRA – Tax Equity and Fiscal Responsibility Act of 1982, DEFRA – Deficit Reduction Act of 1984, and TAMRA – Technical and Miscellaneous Revenue Act of 1988. These federal laws were passed to ensure that the tax advantages of life insurance are not misused or abused. In this episode of Money Script Monday, Sean shows you how to properly fund an IUL policy in accordance with the federal laws: TEFRA, DEFRA, and TAMRA.
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Video transcription
Hello, and welcome to another edition of Money Script Monday. My name is Sean Brady. Today, we're going to be talking about how to properly fund an indexed universal life (IUL) policy per the IRS guidelines.
In early 1980s, many people started to go in more predictable and tax-favored path.
EF Hutton, a brokerage firm, are generally regarded as the masterminds behind structuring life insurance in a way that allows people greater safety of their money, and less volatile rates of return on a tax-free basis.
They were the ones who really helped people pursue this unique financial strategy.
They began to reposition serious amounts of cash into maximum funded life insurance policies for the primary purpose of accumulating their capital on a tax-free basis for goals such as retirement.
They took out small life insurance death benefits and they put in the most premiums allowed.
Again, they were taking out the least amount of insurance and putting as much premium as they could as quickly as they could.
The IRS came in and challenged what was being done. EF Hutton went to court and they won the case. They were in complete compliance with section 72E of the internal revenue code.
TEFRA, DEFRA, and TAMRA
Since the 1980s tax laws and tax codes related to universal life have changed over time, and really evolved.
And since taxes have a profound impact on your wealth accumulation, it'd be wise for you to really understand these key tax codes:
TEFRA and DEFRA
Legislators passed the Tax Equity Fiscal Responsibility Act of 1982 known as TEFRA.
Two years later the government passed the Deficit Reduction Act of 1984 known as DEFRA.
Under these laws the TEFRA DEFRA corridor was established.
This corridor dictated the minimum amount of death benefit required based upon an insured's age, gender, and health, to accommodate the aggregate premium basis allowed into the life insurance policy.
If a policy doesn't comply with the TEFRA DEFRA corridor then that would exceed the definition of life insurance, and that policy would no longer get to enjoy the tax-free status of section 72E internal revenue code, nor would it allow them to access their money tax-free under section 7702.
Now, more and more Americans behind this still see the value behind putting their money to these types of accounts, and when this was happening banks and credit unions began to complain.
TAMRA
In response, the government passed the Technical and Miscellaneous Revenue Act in 1988, also known as TAMRA.
TAMRA slowed the amount of money going into universal life contracts.
Simply put, the TAMRA citation policies after June 21, 1988 no longer could fund a maximum single premium under the maximum TEFRA DEFRA guidelines.
Those policies would no longer get to enjoy the tax-free income streams if they were to fund it in one year.
The Guideline Single Premium, or GSP, is the max amount you could put in, in the initial 11 years or so.
Since people wanted to fund in the GSP in the very first year, TAMRA required them to spread those funds over a five to seven year time frame.
When you're structuring a life insurance policy as a superior capital accumulating and tax-free income vehicle, it is crucial that you understand the tactics to lower their life insurance costs to accommodate that Guideline Single Premium.
Many financial professionals are not taught these strategies, nor do they understand them.
So it is crucial that you work with someone that knows how to properly structure these types of policies so it could give you the optimal performance.
When you've decided on the amount of money that you'd like to put into one of these contracts over a specified time frame, we would then solve for the maximum TEFRA DEFRA guideline death benefit using sophisticated software.
You would then fund in that premium that you would like to put into the policy as quickly as you can and as fast as the IRS will allow.
How to Properly Fund an IUL Policy
Now, let's compare your indexed universal life policy to this bucket here.
Premium and Death Benefit
The size of the bucket is determined upon the amount of premium that you'd like to put into your policy, and the death benefit that's going to accommodate that amount of premium at your specific age.
Let's say, this particular bucket has the room for a $250,000 premium, and with that is going to come a $650,000 minimum level death benefit.
You could fully fund and fully fill up your bucket in just five equal payments of $50,000 over that five-year time frame, and you'd have a fully-funded, max-efficient, indexed universal life policy.
This is what we call a short-term design, or what we call bucket funding.
There are people that have the time, the capital, and the cash flow in hand and they say, “I want to pay $50,000 for 10, 20, 30 years. Can you still do that? What's that bucket look like?”
All you'd have to do is instead of a minimum level death benefit, you'd have a minimum increasing death benefit.
As you fund for 10, 20, 30 years, once you're done funding, you would then switch to level death benefit.
Essentially, it's just a way of filling up new buckets of money without having to purchase new policies every single time.
Both designs are max efficient, it's where we're squeezing down the policy costs and increasing your earning potential.
Insurance Mortality & Expense Charges
Now, there are annual costs associated with your policy, and those costs include life insurance, the pure cost of life insurance, and any other fees associated with managing the policy.
In this illustration, those fees are represented down here at the bottom by this spicket.
Before you view the outflow or cost flow of this as a negative, consider that it's actually going to work for you.
It's going to pay for that valuable life insurance death benefit that's going to your loved ones.
It's essentially watering this little money tree, and that's going to grow and transfer to your beneficiaries tax-free upon your passing.
When you open an indexed universal life policy, or buckets, you're going to want this spicket to drain the least amount possible, so your internal rate of return is the highest possible.
That is the key idea to properly funding your indexed universal life policy with respect to the IRS guidelines.
That concludes today's presentation. Thank you for watching. We'll see you next time on Money Script Monday.