How to Properly Fund an IUL Policy Per the IRS Guidelines
In the early 1980s, many people began seeking financial strategies that offered more predictability and tax advantages. EF Hutton, a well-known brokerage firm, played a key role in developing a unique way to use life insurance to provide greater safety for money and steady, tax-free growth.
Their approach involved using maximum-funded life insurance policies. The goal wasn’t primarily about life insurance for protection—it was about growing wealth in a tax-advantaged way for purposes like retirement. They minimized the death benefit and focused on contributing as much as possible to the cash value portion of the policy, maximizing its tax-free growth potential.
This strategy drew the attention of the IRS, which questioned its compliance with tax laws. However, EF Hutton stood their ground, and after going to court, they proved that their approach fully complied with Section 72E of the Internal Revenue Code. This victory solidified the use of life insurance as a powerful financial tool for building wealth and achieving long-term financial goals.
Since the 1980s, tax laws and regulations surrounding universal life insurance have changed and evolved. Because taxes play a significant role in how you accumulate and grow wealth, it’s important to understand a few key tax codes: TEFRA, DEFRA, and TAMRA. Here’s how these laws affect your ability to use life insurance as a powerful financial tool:
TEFRA and DEFRA: Establishing Guidelines
In 1982, the government passed the Tax Equity and Fiscal Responsibility Act (TEFRA), followed by the Deficit Reduction Act (DEFRA) in 1984. Together, these laws introduced what’s called the TEFRA DEFRA Corridor.
This corridor set the minimum amount of death benefit a life insurance policy must include based on factors like your age, gender, and health. It also defined the maximum amount of premiums you could put into the policy without exceeding the legal definition of life insurance.
If a policy doesn’t meet the TEFRA DEFRA corridor rules, it loses its tax advantages. Specifically:
It no longer qualifies for tax-free growth on your cash value (Section 72E).
You can’t access your funds tax-free (Section 7702).
Even with these limitations, many Americans continued to see the value in using life insurance for tax-advantaged savings, which caught the attention of banks and credit unions. This led to further regulation.
TAMRA: Slowing Down Contributions
In 1988, the Technical and Miscellaneous Revenue Act (TAMRA) was introduced to limit how quickly people could put money into universal life policies.
Before TAMRA, you could deposit a large lump sum (called the Guideline Single Premium) into a policy to maximize its tax benefits. TAMRA changed that by requiring those funds to be spread out over five to seven years, rather than in a single year.
This change prevents people from overfunding their policies too quickly while still maintaining the tax-free benefits.
Why These Laws Matter
When using a life insurance policy as a way to build wealth and create a tax-free income stream, understanding how these rules work is crucial. You’ll need to:
Lower the cost of insurance to free up more cash for growth.
Fund your policy within IRS limits to keep its tax advantages intact.
Work with an experienced professional who understands these complex rules and can properly structure your policy.
How We Help You Maximize Performance
If you’re interested in using life insurance to grow wealth, we start by determining how much money you’d like to contribute over time. Then, using advanced software, we calculate the minimum death benefit required under the TEFRA DEFRA guidelines. This ensures your policy stays compliant while maximizing its growth potential.
From there, we help you fund your policy as quickly as allowed, balancing performance with compliance. This strategy can provide you with a powerful, tax-advantaged financial solution.
Working with the right professional ensures your policy is structured correctly, so you can enjoy all the benefits of a properly designed universal life plan.
Premium and Death Benefit: Building Your Bucket
The size of your policy’s “bucket” is determined by two factors: the amount of premium you want to contribute and the death benefit required to accommodate that premium based on your age.
For example, let’s say your bucket can hold $250,000 in premium. To align with IRS rules, this bucket would come with a $650,000 minimum death benefit. You could fill the bucket by contributing $50,000 annually for five years. After that, you’d have a fully-funded, highly efficient indexed universal life (IUL) policy. This is known as a short-term design or bucket funding.
If you prefer to contribute for a longer period—say, 10, 20, or even 30 years—we can adjust the design. Instead of using a minimum level death benefit, we’d use a minimum increasing death benefit. As you fund the policy over time, the death benefit grows with your contributions. Once your contributions are complete, the death benefit switches back to a level amount.
This approach allows you to fill new “buckets” of cash value without needing to open additional policies. Both designs aim to maximize efficiency by reducing policy costs and increasing your earning potential.
Insurance Costs: Mortality & Expense Charges
Every life insurance policy has costs, such as life insurance charges and fees for managing the policy.
While these costs might seem like a downside, they serve an essential purpose. They fund the death benefit, ensuring your loved ones receive a tax-free payout when you pass away. In a way, these costs are like watering a money tree that will grow and eventually transfer wealth to your beneficiaries.
The key to maximizing your policy’s value is to minimize this outflow, keeping the internal rate of return as high as possible. A well-structured indexed universal life policy strikes this balance, ensuring your bucket works as efficiently as possible while staying compliant with IRS rules.
