Hi again. Doug Andrew here. I'm going to address in this episode what are tetra
and Defra tax citations? When you understand this, this will be a
game-changer on being able to accumulate your money tax-free access it tax-free
and of course, when you finally pass away, it blossoms and transfers tax-free. The
key here is to understand the sort of hoops we have to jump through in order
to make sure that we can do that. And so, I'm gonna go into an explanation of how
Tefra and Deffer came about. Their acronyms it stands for the Tax, Equity,
Fiscal Responsibility Act of 1982. And also the deficit reduction act of 1984.
So, here we go.
So, back in 1980 when E.F Hutton, the brainchild behind max funded insurance
contracts came out with the concept of, "Hey, instead of having the most amount of
insurance you might want for the least premium, let's flip that. Let's have the
least amount of insurance the IRS will let us get away with. And put in the most
premium so this turns into a living benefit, a cash cow as fast as the IRS
will allow." So, hence Tefra, Defrar and Tamra came about. Because the IRS came
around snooping "what are you doing?" And so they actually challenged EF Hutton.
Because there was this massive exodus of money leaving the banks of the brokerage
firms into max fund insurance. Because they paid higher interest. They were
tax free. They blossomed when you died and so they had a lot of benefits that
many of the other places people put their money did not have. And so, was the
money began to go, first of all the IRS came in and said, "Hey, what are you doing?"
Now, they were saying that to E.F Hutton and the clients that they were doing
this for. And they actually went to court because E.F Hutton said, "If we take the
least amount of insurance to put in the most premium, people were paying like
$500,000 for a dinky amount of life insurance. And they would say who does
that?" And they would... E.F Hutton would say, "Our clients do." Because they were using it
primarily for the living benefits under Section 72(E) and 7702 which I explained
in other episodes. Well, they went to court. E.F Hutton won. They weren't doing
anything wrong. But then the IRS went to Congress and said, "You know what? We think
that they are abusing these sections of the code which allow for tax-free
accumulation and access in insurance contracts." So, they decided to define or
redefine what tax free life insurance is under these sections of the code. And
so, in 1982 under part of the tax equity, Fiscal Responsibility Act which spells
the acronym Tetra. They made their first attempt. Well, they didn't know quite what
they were doing. How unusual is that? The IRS doesn't even know what they're doing.
And so, 2 years later, they had to sort of redefine it again under the deficit
reduction Act. And that's called Defra. And so, this became the Tefra, Defra tax
citation or corridor. Now, what this means is basically this: (I would use the
metaphor of a bucket) So, if I had a client or if I wanted to do this myself,
I want to establish an insurance contract, a bucket a repository to put my
money primarily for living benefits. But I also had to justify a death benefit. I
still had to qualify for insurance and have reason and justification for the
amount of insurance I was applying for. You just can't go out and insure
yourself for billions of dollars. You have to prove that somebody would suffer
an economic loss by virtue of your death. Otherwise we have crazies out there that
tie bombs around them and blow themselves up and they would leave
behind millions and billions of life insurance to their cult. And so, you have
to qualify. You have to have a certain amount of income or net worth to have so
much insurance. When you set up an insurance contract for the purpose of
living benefits, you're trying to have the least amount of insurance. So, over
here this is the minimum death benefit required under Tefra and Defra as I'm
going to explain. And then you're wanting to put in the amount of money that you
choose to. So, I call it like the backdoor approach. Instead of saying how much life
insurance do you want or need, sometimes they say, "Well, wait a minute. How much
money do you want to sock away and be grandfathered to grow tax-free, be able
to access your growth tax-free?" And when you die up blossoms and transfers
tax-free, under sections 72(E) 7702 and 101(A). And so, Tefra different dictated
the minimum of insurance. Now, let's say I
wanted to reposition 500,000. There's nothing magic about
this. But I like to use a consistent example. If you wanted to be grandfather
to put in 500,000. You're not obligated to put that in. But it
would behoove you to do so. This is the amount that you're allowed to put in as
500,000. Now, there's no limit to what this can grow to with
interest and dividends or whatever. There's only a limit to how much you can
put in. So, that's 500,000. All of the compound interest that you
earn on that five hundred thousand is tax-free under Section 72(E). But when
they went to Congress they said, "You know what? You need to have a commensurate
amount of life insurance. Sort of coming along for the ride.
So, that this does not move over to taxable investment section of the code.
It stays tax-free." And so, this is where Tefra, Defra and Tamra came into play.
Now, Tamra is the technical and miscellaneous Revenue Act of 1988. And
that's where you have to spread out the funding over a minimum of 5 years if
it's universal life. If it's whole life, it's usually 7 years. It's called the
7-pay test. That's one of the reasons why I like universal life. It's more
flexible. And I can fund it in 5 years instead of taking 7 years. And it
usually outperforms whole life by about 2 percentage points. So, I prefer the
universal life which is the brainchild of E.F Hutton. That in order to be allowed
to put in let's say $500,000, you had to have a
certain amount of insurance coming along for the ride, so to speak. Now, the neat
thing about Tefra and Defra is it gave parity. So, let me explain what parity
means. So, let's start out by saying what's disparity. That's unequality. So,
parity was designed to give sort of an equal opportunity realizing that some
people were young, some people were older. Some people were really old. And if their
objective primarily was for living benefits,
because it's called life insurance, they wanted to make sure it was sort of fair.
And so, it didn't matter if you were a 22-year old athletic
marathon running female. Or a 67-year old geezer like me. Or an 80 year old. I think
of a friend of our family who is 80 when he came to us and he had 3 blocked
arteries that were cleaned up with angioplasty.
He had adult onset diabetes and a prostate cancer episode. He had 6
sisters and three brothers pre deceasing. And yet we were still able to get him an
insurance contract because he had a better lifestyle than his siblings. He
doesn't use tobacco or alcohol and so forth.
The key with Tefra and Defra is the cost of the insurance or rather the
amount of insurance required under Tefra and Defra tax citations
goes down as you get older. Which means if I were 22 years old and I wanted to
be grandfathered to put in 500,000 into my bucket my insurance
contract, I might be required to have 5 million of life insurance. Now, that
5 million of life insurance is only draining out a small percent of the cost.
Or the cost of that is usually only 1 percentage point if I'm earning 11%,
let's say, I'm netting 10. If I'm earning 8, I'm netting 7. If I'm
earning 15, I'm netting 14. But the cost of the insurance which is like
this spigot on the bucket has to be there under Tefra and Defra. The point
is the parity said, "if I'm 67 years old
and I want to be grandfathered to put in
500,000, I only need a 1,250,000 of insurance. That insurance
costs no more than the 5 million for the 22-year-old. And so, if I'm 80,
maybe the insurance required might be 850 or 900
thousand. Because you're doing it so that the 500,000 you're putting in will have
the highest net internal rate of return so that if you're earning 11 like I did
back in 1980 to 1990, I'm netting 10. What does that mean? It means the 22-year
old... If a 22-year old put in 500,000 can earn a net
10 and the 67 year old and the 80 year old because the amount of insurance
required under Tefra and Defra goes down as you get older. So, that
everybody can have the same net internal rate of return. See, the myth is "Oh, as you
get older, insurance is more expensive. If you structure it correctly here, the
insurance can actually get cheaper as you get older."
Have you ever seen an insurance policy that gets cheaper as you get older? Then
you haven't seen one designed correctly under Tefra-Defra guidelines. So, let me
show you how this all comes together. With Tefra and Defra, I can then
design my insurance contract to have the best internal rate of return so that the
cost of the insurance --the spicket on this bucket is draining out no more than
about one percentage points at the end of the day. Which is actually watering a
nice little money tree here that's going to blossom when you die. Again, we don't
object to insurance benefits. We objective paying for it. This 1%, when you
think about it it would be otherwise payable tax, if I put my money in a
tax-deferred IRA or 401k maybe in the market. Because I might have to earn 15%
to then pay tax and only net 10 or 9. Here I only have to earn 11 to net 10.
Because that 1% is not tax. It is the cost of the insurance that is required
under Tefra and Defra. But because of parity, I can get the same rate of return.
An 80-year-old can get the same rate of return by squeezing down the death
benefit. Tamra says that we have to spread out the funding over 5 years
in order to access your money tax-free. I explained that in another episode. The
point I want you to remember is that if we comply with Tefra, Defra and
Tamra guidelines, then the money we take out is not deemed earned passive or
portfolio income. Which are the only three types of income we pay income tax
on. I have clients who start taking out 50 or a
100 thousand. One client takes out 800 thousand a year and it's
not being earn passive report folio income. There's nowhere on a tax return
to put it. It's tax-free it is that cut-and-dried because they complied with
Tefra, Defra and Tamra guidelines which requires a professional to help
you understand how to do this correctly. So again, instead of sitting there with
an IRA or 401K, hey let's just enjoy the seat without paying tax and then pay tax
on the harvest. Ah! I would rather pay tax on the seed and enjoy the harvest
without tax. But I would rather have a place where I can harvest the money
tax-free. And when they ultimately pass away it blossoms and transfers tax-free.
So, are you beginning to get it? In other words, I like to use this metaphor. Don't
focus on what it is. Some people say, "Oh, I don't need any more life insurance " Okay.
What does I have to do? It make me the beneficiary then. In other words, I'm
using that. I focus on what it does when I ask an audience. Let's say with women
in the audience. What are some uses for baking soda? And some say "Oh, well. It
could be used in the bathtub to soak. It can take the odor out of the
refrigerator. And it can take the pop out of a pot of beans." And then somebody
finally goes, "Oh! It's good for baking." Yeah, life insurance is good for life.
Even better than for the death benefit. So, if this is resonating with you, I
would encourage you to watch this episode so you can see how this all
comes together and the dots get connected. And then you'll have an
opportunity to receive a copy of one of my books for free. If you like to really
take a deep dive into educating yourself.