Maxed-out universal life insurance tax laws refer to the Tax Equity and Fiscal Responsibility Act of 1982, Deficit Reduction Act of 1984, and the Technical and Miscellaneous Revenue Act of 1988. Collectively, these are known as "TEFRA," "DEFRA" and "TAMRA." Combined, they outline how a life insurance contract can be funded. Violation of these funding guidelines can cause your universal life insurance contract to become a modified endowment contract and it will lose all of the tax benefits associated with life insurance.
Obey DEFRA guidelines when funding your universal life insurance. Since DEFRA modified, expanded and essentially defined universal life insurance, DEFRA laws must be obeyed in order to maximally fund your universal life insurance policy. DEFRA spells out something called a "cash value corridor test" or "guideline premium test." The guideline premium or guideline single premium limits the amount of total premium that the contract can accept based on the death benefit that is initially purchased.
Make sure you fund the universal life insurance policy according to Section 7702A of the Internal Revenue Code. This section delimits the "seven pay test" for your universal life insurance policy. It requires that the cumulative life insurance premiums you pay over any period of seven years during the contract not exceed the seven pay premium limitation. The seven pay premium limitation is set by the insurance company and is based on your age, health, sex and the costs of the policy as well as the death benefit amount.
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Avoid having the life insurance contract become a modified endowment contract. TAMRA defined a modified endowment contract, or MEC, as a life insurance contract that fails to meet the seven-pay test outlined under Section 7702A. Once a life insurance contract becomes an MEC, it loses some of its tax advantages. It also is treated as a qualified retirement account for cash withdrawals. This means that if you withdraw money from the cash value account prior to age 59 1/2, then you will be assessed a penalty of 10 percent of the amount withdrawn plus be subject to ordinary state and federal income taxes. However, the death benefit proceeds are still considered to be transferable on a tax-free basis. Once your universal life insurance policy has become an MEC, it cannot be undone. The tax advantages are gone forever.