What are Section 7702 plans (are they real investments at all)?


    Section 7702 plans

    There are a number of tax-deferred retirement accounts in the US that make up a alphabet soup of acronyms. The complexity gives salespeople the opportunity to present unsuspecting consumers with “fake” retirement accounts.

    “Plans according to § 7702” are a prime example. Section 7702 of the Internal Revenue Service governs life insurance taxation. And it’s true that some of the tax benefits in Section 7702 mimic the benefits of qualifying retirement plans.

    But these life insurance plans are not alternatives to employer-funded retirement plans or other qualified plans. You are a completely different product. Here’s what you need to know about 7702 plans.

    Section 7702 plans are not retirement accounts

    “Section 7702 Plan” is just a fancy term some insurance agents use to refer to a cash value life insurance policy. They are sometimes referred to as “Section 7702 Pension Plans”, but these are not qualified retirement provision.

    The nomenclature is a marketing nickname designed to entice people to view the life insurance policy as a viable alternative to legitimate tax-deferred retirement accounts.

    Here, too, the 7702 “Retirement Plan” is not a qualified retirement account. It’s life insurance – and usually an expensive one.

    What are cash value life insurances?

    Cash value life insurance is life insurance with a savings component. The savings build up to present value. The value tends to increase over time as the “cash value” included in the policy pays interest or grows due to investment growth.

    Policy account growth is tax deferred. That means it won’t be taxed until the money is withdrawn from the policy account.

    All of these policies require policyholders to pay monthly premiums to maintain life insurance and build the policy’s cash value. All policies pay a death benefit if the policyholder dies. The savings part of life insurance builds up and is invested over many years.

    The exact investments and returns vary depending on the type of insurance policy. Here are three of the most common types of cash value insurance:

    Whole life

    As a rule, life insurances have a guaranteed minimum growth rate for the present value of the policy. However, they can grow a little faster depending on the fund’s performance. If the cash value is sufficiently built up, the cash value can be used to pay the monthly premiums.

    Variable universal life

    With a variable universal life policy, the cash value of a policy can rise or fall depending on the type of investment. Policyholders can have control over how the funds are invested. The potential volatility can create problems for those looking to borrow from the policy to cover the cost of living.

    Indexed Universal Life

    The present value in indexed universal life insurance is linked to a certain stock market index. In these policies, the return on cash value will not fall below 0%. But the benefit is limited compared to the variable universal life.

    Understanding of the plans according to Section 7702

    Section 7702 of the Internal Revenue Code sets out the tax rules for life insurance with “cash value”. Cash value life insurances (also called whole life or guaranteed life policies) are primarily life insurances. If the policyholder dies, his beneficiary receives a large payout from the insurance company.

    Almost all cash value life insurance policies are Section 7702 compliant. By complying with the rules in Section 7702, the cash value within the life insurance policy can grow tax-free.

    In addition, account holders can “borrow” against the accumulated cash value within the policy, either to pay the premiums or to finance the cost of living. This “tax free loan” can be used to trick unsuspecting consumers into viewing cash value life insurance as a viable alternative to a retirement account.

    Related: 401k credits: the good, the bad, and the ugly

    Are 7702 Life Insurance Policies Bad?

    Cash value life insurance is not necessarily a bad product. But they don’t go that well with the typical person. Due to high sales charges and commissions, the present value has been growing slowly for several years. This could explain why, in the latest study by the Society of Actuaries, 20% of people let their entire life insurance policy expire in the first three years.

    Life insurance policies with a cash value have tax advantages. But most people do not have enough income to cover all of their expenses and use their actual retirement accounts. In 2021, a working person with an above-average annual salary of $ 80,000 with high deductible health insurance for their family is entitled to all of the following:

    That’s $ 32,700 in tax-deferred investment opportunities. When you factor in other financial priorities like paying off debt, buying a house, or saving up for the kids’ college, a 7702 plan is unlikely.

    But if you’re already getting out of hand with your financial goals and still have strong cash flow, a cash value life insurance policy can be a useful part of estate planning. But even those who meet the bills should consult a fiduciary financial advisor before purchasing cash-value life insurance.

    Should I cancel my Section 7702 plan?

    Life insurance with a cash value is usually not the best buy to begin with. However, it is important to understand that the fees are usually preferred. So older life insurance can be valuable if you can afford to pay the premiums.

    This post by CFP Michael Kitces helps explain scenarios where it might make sense to keep the policy. Again, you can work directly with a CFP to analyze whether the policy should be kept.

    Final thoughts

    Overall, Section 7702 plans are legitimate life insurance products. And they have a place in certain financial plans.

    But profiteers can try and sell you an expensive policy even if it is not the right choice. Ultimately, it is up to you to research these plans and carefully weigh their pros and cons before buying a policy that you don’t need.


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