7702 Plans: What You Need to Know

Many insurance agents market “7702 plans” as a type of retirement plan and explain it to be similar to typical retirement plans, like a 401(k). Sometimes important details are ignored in this process. We’re going to break down what 7702 plans really are, what these plans mean, and how they relate to life insurance policies.

True definition of 7702 plan

What Is a 7702 Plan?

Though some may say “7702 retirement plan,” a 7702 plan is not a retirement plan. It’s a life insurance policy. In fact, all life insurance policies could be called “7702 plans” because all life insurance policies are covered by section 7702 of the Internal Revenue Code (IRC). Tax code 7702 determines how the federal government taxes proceeds from a life insurance contract. If designed correctly, an IRS 7702 regulated insurance policy will provide tax-advantaged benefits. 

Many insurance agents use the term “7702 plan” to avoid saying life insurance right away in conversations with potential clients. But obviously, life insurance is not inherently bad if it’s set up correctly to meet the proper needs, so it isn’t necessary to call it a 7702 plan.

Here at Life Benefits, we design or review “7702 plans” for our clients daily – and we call these policies by their authentic names: Participating Whole Life Insurance, Indexed Universal Life Insurance, etc.

Many advisors will tell you that you should pay as little as possible for your life insurance. But high premiums are not always bad when you’re in the right financial situation. In fact, when a policy is designed well, higher premiums can help you build cash value and overcome the cost of insurance faster.

7702 plans are cash value life insurance policies with higher premiums than term insurance policies. The benefits of owning high-premium-high-cash-value life insurance turn out to be many. We talk about some of the benefits later in this article.

How Do 7702 Plans Work?

How a 7702 plan works

7702 plans work just like life insurance policies because they are life insurance policies. Your premium goes to purchase a death benefit. The plan may build cash value as well. After death, your family is paid the death benefit. The cash value can be used during your lifetime either by taking a withdrawal or leveraging that value to take a policy loan from the insurance company. Think of cash value as your equity in the life insurance death benefit.

7702 Plan Requirements

There are a few requirements that section 7702 puts in place in order for life insurance policies to receive tax-favorable treatment. With a well-designed life insurance policy, you should not have to worry about your policy failing these requirements. Here is some general, information on these tests:

  1. Cash value accumulation test (CVAT): According to the U.S. House of Representatives Office of the Law Revision Counsel this test means “the cash surrender value of such contract may not at any time exceed the net single premium which would have to be paid at such time to fund future benefits under the contract.”
  2. Guideline premium and corridor test (GPT): In the same counsel section, the GPT test requires that “the sum of the premiums paid under such contract does not at any time exceed the guideline premium limitation as of such time.”

If a life insurance policy were to fail either of these tests, then money accessed through the policy contract would be taxable on a Last-In-First-Out basis and, similar to a tax-qualified plan, may also face a 10% penalty before age 59 ½. Most insurance company’s illustration software is built to run these tests automatically in the background, so you don’t have to worry about the technical calculations. 

If you ever make a change to a life insurance policy which causes the policy to fail one of these tests and become taxable as a modified endowment contract, the insurance company will notify you and you usually have up to 12 months to reverse the action which caused the issue.  

How Does A 7702 Plan Differ From A Retirement Plan?

There are a couple of key differences between a 7702 plan and typical retirement plans like a 401k or Roth IRA. A life insurance policy’s cash value is available to you to use during your life, and it will pay out the death benefit to those you name as beneficiaries of the policy. Retirement plans can also list beneficiaries but there is not typically a death benefit associated with these plans; rather the beneficiaries receive the remaining account value as an inheritance.

Another difference is how taxes are calculated. When looking at 401k vs 7702 plan, taxes can play a huge role in the pros and cons. Cash value in a  well-designed life insurance policy will always be partly tax-free and partly tax-deferred. Money in 401(k)s, on the other hand, is only tax-deferred. This means that while you won’t pay taxes when you put money into a 401(k), it will all be subject to income taxes when you withdraw the money. Life insurance premiums are usually paid with after-tax dollars and these funds can be withdrawn tax-free (First-in First-out treatment) before taking passive income from the tax-deferred portion of the policy values in retirement.

Because of this, saving for retirement with whole life insurance can open better options for more sustainable retirement income than typical financial planning which relies mainly on tax-deferred plans such as 401(k)s and IRAs.

Even though it is not accurate to refer to an IRS 7702 account as a “retirement plan,” good life insurance policies like we design at Life Benefits can put you miles ahead when it comes to saving for retirement

A typical investment portfolio cannot provide guaranteed growth. A good life insurance policy will provide guaranteed growth on your money. This guaranteed growth gives you confidence and financial peace of mind.

Section 7702 Changes

In December 2020, Congress made changes to section 7702 for the first time since it was created 32 years before in 1988.

Through the Consolidated Appropriations Act, the minimum interest rates to be used in the design of cash value life insurance products were changed to allow for the continued low-interest rates across the rest of the economy.

Existing policy owners do not need to worry about their guaranteed policy values since these changes do not affect existing policy guarantees unless significant changes are made to an existing policy.

As of January 2022, life insurance companies have updated their new products in accordance with this legislation. Many companies have endeavored to keep high guaranteed cash values while dividends are projected somewhat lower across the industry. Premiums tend to be slightly higher in order to build similar cash value. 

None of these changes negate the value of using whole life insurance as an important financial tool and a liquid form of savings in addition to the permanent death benefit.

Seeing the numbers from the insurance companies we represent here at Life Benefits, we think the findings of the Society of Actuaries have been reflected pretty accurately across the industry resulting in:

  • higher guaranteed cash values;
  • higher premiums to support those cash values;
  • lower net amount at risk (less mortality risk);
  • premiums and dividends applied to buy paid-up adds would purchase less death benefit; and
  • less risk to the company in a sustained low-interest-rate environment.

Summary

A 7702 plan is not a retirement plan. It’s a section of the internal revenue code that dictates how life insurance will be treated for tax purposes. Some experts say life insurance is the single largest benefit in the tax code. 

Life insurance is not just effective for providing financial protection for your loved ones when you die, it is also a great way to grow your wealth while you’re alive. It can provide retirement income for you in your golden years, and it lets you leave money to your spouse, your children, and your grandchildren income tax-free!

To see the number for a well-designed policy and how this could benefit you, call Life Benefits at 702-660-7000 or schedule a time for us to call you.

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