The 7702 Plan- What Are the Pros and Cons- What to Do Now?
What are 7702 plans anyways? What are they good for and how do they benefit you is the answer I’m sure all of you are looking for. Otherwise, you would have no reason to have googled the term and be actively searching the results for the best answer, so that you can finally understand what a 7702 plan is.
To give you a brief explanation before going entirely in depth a 7702 plan is something you should most likely avoid and it’s an abbreviation for a tax code with the IRS (Internal Revenue Service)
Understanding life insurance and how it works can be confusing especially when the industry can tend to be less uniform with explanations or market some life insurance products more than others. If your a little lost or feel you need some background information about life insurance first, always feel free to check out our dedicated page that’s a full life insurance tutorial from start to finish in plain English that’s easy to understand. It breaks down permanent insurance as well so it can give you a leg up on understanding some of these terms we will cover in the blog. If not and your ready to go, let’s move on and keep plugging away at these 7702 plans.
Our goal is to always provide you with the information needed to make the best decision for your family and financial future.
Life Insurance typically is a not a fun task to complete, but we can assure you it’s much more bearable when your educated about the information and work with an agency who can explain things in depth and tailor things toward your best interest.
Let’s dive into what the 7702 plans is, how it works and what to do next, shall we?
According to Investopedia, a Section 7702 is nothing more than IRS (Internal Revenue Service Code) that defines how our federal government will treat life insurance policies from that tax point of view. A more natural way to word this, how will your life insurance ultimately be taxed?
You see, life insurance has many tax benefits. The Federal Government also knows this information, so it’s always better to be safe than sorry and understand everything presented to you.
Within certain cash growth life insurance vehicles such as Universal Life Insurance, Variable Universal Life Insurance or even Traditional whole life insurance, you have limits on the premiums you can contribute in addition to the benefits that are considered cash value benefits and the benefits that are considered a death benefit.
Section 7702 Plans simply began laying down maximums and setting limits to ensure life insurance was being used for the “correct “purposes, and of course we all know if it’s not, Uncle Sam is going to dip his hand in the candy jar at one point or another.
Let’s break down the 7702 even Further.
At one point in time, the federal government used to be much more hands-off when it came to taxing life insurance policies and governing how death benefits were paid to the life insurance beneficiaries.
In today’s world the death benefit paid to beneficiaries is still tax-free and distributions used to be taxed on a first in and first out basis (FIFO). This is breaking down the interest and gains within the policy that has built up your so to speak “cash value” within the policy and sheltered behind the death benefit.
The government was scared to tax these benefits because it would unfavorable from the public view to see the widow of the deceased spouse or a parent less child losing some of the death benefits that was initially designed to help through the tough time financially and emotionally.
One Bad Apple Ruins It for Us All
Soon, people (especially affluent and wealthy Individual’s) began realizing that these tax benefits could be huge for other reasons outside of the protection of your own family if something happens to us. Once it started getting recognized and abused the tax code was released to limit the amount of money you could “stuff “into a life insurance policy to keep it protected from uncle Sam
Bad Marketing Tactics
Now we move onto to a more recent change in 7702 plans, how they are viewed and what’s going on the financial services and investments world.
Once people started using life insurance in this manner, financial advisors and professionals caught on that this may be great marketing tactic and they could begin advertising these as investments and retirement plans.
This is ridiculous in many ways in our opinion. You would have to have the perfect storm in your financial portfolio for this to make any sense. Investments will always be more significant outside of life insurance, and fees will still be less outside of life insurance.
The reason that these 7702 plans were marketed as retirement plans is that cash value life insurance has a large commission to the agents and ultimately people like hearing the phrase tax benefits or tax-free. Nobody likes paying taxes, and we understand that.
We also don’t like losing money in investing, and since we all know you can do better than the 7702 plan, it’s advisable that you always consider other options outside of the 7702 plans being marketed or pitched at you.
More on IRS Code and 7702 Plans
The significant policies financial professionals are trying to label and use for these “7702” plans are primarily VUL’s (Variable Universal Life Insurance).
Variable Universal Life Insurance is life insurance that has sub-accounts that are used for investments and a vehicle to grow cash value. They work like a mutual fund and are exposed to the same market risk that a mutual fund is exposed to.
It can be a life insurance policy that may experience significant losses, and these policies need to be sold and handled with care by the agents and financial professionals.
Another issue with these 7702 plans and the Variable Universal Life products is that the fees are through the roof. You can expect charges on a VUL to be anywhere in the 4-6% range which may end up looking like even more fees than a standard loading fee in a commonly found mutual fund.
News’s flash, the mutual fund will also outperform the VUL policies 9 times out 10.
By term or Guaranteed Universal Life Insurance and invest the rest. You can thank us later for the sound advice.
What’s the Risk Involved with a 7702 Plan?
As far as the risk with a 7702 plan you have a few that stand out to us like a sore thumb at Good Life Protection.
The first significant risk is that you are being oversold and under delivered by your financial services representative. The commissions on these products and “plans” are high compared to other options, and it’s ultimately lining the representative’s pocket more than anything.
You’re also running the risk of not investing in a better vehicle toward retirements from the get-go which is just the risk of you being broke by the age of 70.
The large commission on these products and 7702 plans will typically lead to the agent or representative being aggressive with sales or “pushy” so to speak.
I’d recommend avoiding the 7702 plans or 7702 Private plans at all cost in most situations but yes, circumstances may make sense for this to be a deployable strategy but rarely.
Should You Consider a 7702 Plan for Retirement?
99% of the time, no you should not and don’t let the agent or representative fool you into thinking that it could be a right strategy for you.. Anytime life insurance is discussed as an awesome “investment vehicle” you should be worried because life insurance Is NOT, and we will repeat that NOT an excellent investment vehicle.
It can have some upside to having a cash value plan inside your portfolio but when it comes to building a nice retirement, but overall, stick to the traditional methods such as IRA’s and 401K’s.
What’re your thoughts on the 7702 Plans? Any Experience With 7702 Plans?
Any thoughts from the readers on 7702 plans? Do you have one currently or have been considering one?
Overall, we want to make sure we emphasize that all situations are different, but you need to be careful about the plans that impact your retirements and financial futures.
At Good Life Protection we believe that life insurance was designed to protect first. Not invest and build cash. Can it make some money and maybe help aid some in retirement planning? Sure, but most likely it’s not going to be the strongest performer in your financial portfolio. Stick with the term and invest the rest.
If you’re looking for a term life insurance quote, make sure to fill out the rating engine on the right to get started. It’s free to run the rates, and it will give you a chance to see how much extra money you can add to your IRA by going with term life insurance instead.
Have we left anything out? Be sure to drop a comment below. We would love to hear from you.
Till Next Time, we appreciate you.
Josh Martin is the founder of Good Life Protection. He began his career as a captive Agent working for New York Life Insurance Company. After continued education and designations, Josh founded Good Life Protection to provide consumers with more options and insurance that truly fits into your budget and health classification.