Life Insurance & TEFRA

The Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982 introduced guidelines for determining the tax treatment of life insurance contracts. This article provides an overview of TEFRA’s origins, key provisions, and implications for policyholders and the life insurance industry.

Life Insurance – TEFRA |History and Purpose:

 TEFRA was enacted to address federal budget deficits and improve tax equity and fiscal responsibility. Among its many provisions, TEFRA included specific guidelines to ensure that life insurance policies qualified for tax-favored treatment, preventing policies from being used primarily as investment vehicles rather than for protection purposes.

Key Provisions:

• Definition of Life Insurance: TEFRA established tests to ensure policies qualify as life insurance under federal tax laws. These tests include the Cash Value Accumulation Test (CVAT) and the Guideline Premium Test (GPT).
• Cash Value Accumulation Test (CVAT): This test ensures that the policy’s cash value does not exceed certain limits relative to the death benefit, maintaining its status as a life insurance policy.
• Guideline Premium Test (GPT): The GPT limits the amount of premiums that can be paid into a policy to prevent excessive funding that could be construed as an investment rather than insurance.

TEFRA Implications for Policyholders:

• Tax Advantages: Policies that meet TEFRA’s requirements retain their tax-favored status, with death benefits generally received tax-free by beneficiaries.
• Policy Design: Life insurance companies design policies to comply with TEFRA’s guidelines, ensuring they offer tax benefits without exceeding allowable limits.
• Tax Planning: Policyholders need to be mindful of premium payments and cash value growth to maintain the policy’s favorable tax treatment.

TEFRA plays a crucial role in defining the tax treatment of life insurance policies, ensuring they serve their intended purpose of providing financial protection to beneficiaries. 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 TEFRA’s complexities and structure your policy to meet your financial goals while maintaining favorable tax treatment.