Life Insurance | Deficit Reduction Act (DEFRA)

The Deficit Reduction Act (DEFRA) of 1984 introduced additional regulations on the tax treatment of life insurance policies, particularly focusing on the accumulation of cash values. This article explores the origins, key provisions, and implications of DEFRA for policyholders and the life insurance industry.

Deficit Reduction Act (DEFRA) | History and Purpose:

DEFRA was enacted as part of a broader effort to reduce the federal budget deficit. Among its many provisions, DEFRA included specific measures to address the use of life insurance policies as investment vehicles, ensuring that these policies maintained their primary purpose of providing financial protection.

Key Provisions:

• Guideline Premium Test (GPT): DEFRA reinforced the GPT introduced by TEFRA, limiting the amount of premiums that can be paid into a policy to prevent excessive funding.
• Cash Value Corridor Test: This test ensures that the relationship between a policy’s cash value and its death benefit aligns with tax regulations, preventing policies from being used primarily for investment purposes.

Deficit Reduction Act (DEFRA) |Implications for Policyholders:

• Tax Advantages: Policies that comply with DEFRA’s requirements retain their tax-favored status, with death benefits generally received tax-free by beneficiaries.
• Policy Design: Life insurance companies design policies to meet DEFRA’s guidelines, ensuring they offer tax benefits while adhering to regulatory limits.
• Tax Planning: Policyholders need to be aware of premium payments and cash value growth to maintain favorable tax treatment under DEFRA’s rules.

DEFRA significantly impacts the tax treatment of life insurance policies, particularly regarding the accumulation of cash values. Understanding these regulations is essential for policyholders seeking to maximize the tax advantages of their life insurance coverage. At The Policy Shop, we can help you navigate DEFRA’s complexities and structure your policy to meet your financial goals while maintaining favorable tax treatment.