All employees and entrepreneurs are eligible for the 7702 plan. Basically, this plan may be used as a retirement savings plan, but not so often. This plan derives its name from Section 7702 of the Internal Revenue Code and does not constitute any type of tax-deferred savings plan such as 401(k) or 403(b) plans.
Understanding the Section 7702
The section defines the criteria that the cash value of the life insurance policies have to meet to retain their tax-advantaged status. The Section further lays down the guidelines for premiums paid and defines the corridor and the cash value accumulation tests that have to be met in order for the cash value inside a permanent policy to grow on a tax-deferred basis. The Section rules apply to any cash value life insurance policy that was issued after 1985 which means that Section 7702 is a code, and not a plan. Additionally, “7702 Plans” do not refer to any qualified plans in any sense and any cash value life insurance policy that you buy will be subject to the same tax rules. The 7702 plan can be said to be a life insurance policy. A clever insurance agent or an agency noticed the gap and simply named the policy ‘7702 plan’ after the section from which the policy is derived.
Can 7702 be used as a retirement plan?
When it comes to retirement plans, most people are familiar with the 401(k) and some other individual retirement accounts, however, when asked, most people are not familiar with the 7702 plans which are often advertised as plans that allow savers to access their funds without incurring any tax penalties. In essence, and on the surface, these plans seem to offer much more flexibility as a retirement vehicle. This raises the question, given their many advantages and flexibility, why aren’t they popular?
To answer this question, we need to understand what the 7702 plan is and how they differ from the traditional retirement options.
The 7702 plan/policy is essentially variable universal life insurance policies and the contributions that you make to these policies will grow tax-deferred and can be invested in various other accounts. This means that these accounts do not have an age restriction tied to them but, they however should not be viewed as a retirement plan or as a replacement for one.
The difference between 7702 plans and the retirement plans
The 7702 plan basically is a contract between you ‘the insured’ and the company that is selling the insurance ‘the insurer.’ This contract stipulates that you are to pay premiums to this account and while this plan and other life insurance plans grow tax-deferred, they do not offer any tax deductions as in the case with the retirement plans.
In most cases, markets will advertise the 7702 plans as a retirement plan and there is a good reason for that. Selling life policies can be at times tough but marketing the 7702 plan as a retirement plan makes it easy to sell. These plans come with a hefty commission to the broker and the insurance agents which makes some willing to misrepresent the facts just to close the deal.
Are they any good?
If the 7702 plan is just some life insurance plan with a fancy name, why would someone sell it as a retirement plan? Well, there are some certain advantages attached to these plans, for instance, growing value on a tax-deferred basis, withdrawing funds to put it into other policies without incurring any taxes, and leaving tax free funds to your beneficiaries when you die. Additionally, when you compare the 7702 plan to other retirement plans like the 401(k) and other IRAs, the 7702 plan does not have any contribution limit.
While the 7702 seems like miraculous policies when compared against the other retirement plans, certainly, there are some other drawbacks. There are certain limitations that make these plans very unpopular. Right off the bat, these plans often come with a lot of fees attached to them. This includes things like the contract fees, mortality and expense fees, administrative fees, and many more. Additionally, the 7702 plans come also with a cancellation fee to get out.
What mot sales agents will not tell you is that the 7702 plan has to pass through two tests in order for it to be valid. These are, the cash value accumulation test (CVAT) and the guideline premium and corridor test (GPT). The first test simply states that the cash value for surrendering must not exceed what the holder would have paid if he or she made a single lump-sum payment minus any fees. The second test usually means that the holder must not have paid more than the required amount to fund the insurance benefits included.
Even if the plan passes both the tests, it is not sufficient enough to qualify as a retirement plan. However, the cash value of the policy could be used for retirement. What you need to understand is that life insurance policies are just a backup option to retirement plans. Also, it is good to understand these policies are not backed up by the Federal Deposit Insurance Corporation which means you are not in any way protected in case things go wrong.
