If you think that your Social Security benefits will be sufficient for you to live on in retirement, think again. Regrettably, even if you are contributing to a 401(k) or IRA, you may feel a little safer, but have you considered how your tax liability will impact your retirement nest egg?
The matter gets even more frightful if you are a high-income earner who is generally hampered by the constraints the IRS has placed on traditional retirement plans. Certainly, tax-hungry legislators want you to save for retirement, but only as long as you are willing to give back some of your hard-earned money to Uncle Sam.
It’s time to think outside the box and consider alternative products if you plan on continuing your lifestyle during your retirement years. It’s time to consider an alternative to your Daddy’s retirement plan.
What is an IRS 7702 Plan?
A 7702 Plan is a marketing term that insurance companies and advisors use to market insurance policies that are primarily used to accumulate wealth that you can access on a tax-free basis. It’s likely that life insurance marketing managers prefer terms like 7702, 702(j), or LIRP so the product being offered does not appear at first look to be a life insurance product.
IRS Code 7702 specifies what the IRS considers to be a legal and legitimate life insurance contract and defines how life insurance contracts will be taxed. IRS Code 7702 only applies to insurance contracts issued after 1985. Many financial professionals refer to this as the IRS 7702 clause.
Under this section in the IRC, life insurance contracts must pass at least one of the following tests:
- Cash Accumulation Test – In simple terms this means that the cash value in the policy cannot exceed the single premium that would have been charged to pay the policy in full.
- Guideline Premium and Corridor Test – This means that a policyholder cannot pay more into the policy than would be required to fund its insurance benefits.
Background of IRC Code 7702
Section 7702 of the U.S Internal Revenue Service lays down the requirements that must be fulfilled for an insurance contract to be treated as on a contract and the amount of cash that can accumulate relative to the death benefit. The limits use actuarial calculations to determine the present value of future death benefits using the greatest of 6% or the guaranteed interest rate for guideline single premium and the higher of 4% or the guaranteed interest rate for guideline level and Modified Endowment Contracts. (flag this for plagiarism)
Policies must pass one of the cash-value accumulation tests (CVAT) and guideline premium tests (GPT) so that the cash value build-up will not be taxable. Under Section 7702A, a policy must pass through the 7-pay test so that it is not recognized as a Modified Endowment Contract. Under this test, a life policy cannot receive premiums more than the total premiums necessary to pay up a life policy within seven years.
The IRS code remains important since it dictates which types of cash value life insurance policies are eligible to receive tax advantages. If a life insurance policy does not meet the criteria listed in this section, then the growth of the cash value of the policy is taxable income to the beneficiary.
If at any time at least one of these tests cannot be passed, any income paid on the cash value in the policy will become taxable for that year.
Impact of the Change on IUL
In December 2020, Congress voted to pass the Consolidated Appropriations Act of 2021, which included further revisions to Section 7702. For life insurance contracts issued after 2021, the insurance interest rate will be predetermined only in an adjustment year, which will allow bigger front-loaded premiums for the same amount of IUL death benefits. Effective January 1, 2021, the insurance interest rate is defined as 2% and may now be used to calculate adherences for 2021. From 2022, the market-based rate calculation took effect; however, the insurance interest rate remained at 2%.
The new provision will help permanent life policies to continue being characterized as tax-advantaged life insurance contracts and avoid being classified as other investments whose benefits are considered taxable income. Even though the newer post-7702 IUL policies will accommodate more premiums, the guaranteed lifetime growth of these new policies will be compressed. As a result, more of the cash value growth will thus be tied to the determined index, and less of the total growth will be derived from the company’s guaranteed cash value trajectory within the contract.
Under the new provision, lower interest rates will slash all future IUL policies guaranteed cash value growth rate from 4% to a low of 2%. Implementing lower interest rates in the various calculations under sections 7702 and 7702A will result in increased funding limits for life insurance contracts. Premium limits calculated under the GPT and the 7-pay test have now increased. The changes to these limits are pretty substantial versus the prior limits. Similarly, using a lower interest rate to calculate the single net premium for the CVAT should produce higher cash values
What type of Life Insurance Is Used for a 7702 Retirement Plan?
Any type of life insurance that will accumulate cash value can be used for a 7702 retirement plan. Certainly, some are much better than others, and for the purpose of this article, we will focus entirely on Indexed Universal Life (IUL) because when it’s set up properly, the IUL delivers asset accumulation while safeguarding against any losses.
If you want to know how popular using indexed universal life insurance for retirement planning is, just ask any CEO of a fortune 500 company because 85% of them use an IUL as part of their retirement strategy.
Where traditional retirement products fail, the indexed universal life insurance in your 7702, 702(j), or LIRP succeeds. Also, please note that there is not an insurance product labeled 7702 life insurance since any cash-value life insurance product can be used to fund your 7702 retirement plan.
| Features/Benefits | IUL | Traditional |
|---|---|---|
| Market Volatility | Protected | Exposed |
| Contribution Limits | No | Yes |
| Annual Income Limits | No | Yes |
| Early Withdrawal Penalty | No | Yes |
| Tax-Fee Distributions | Yes | No |
| RMD | No | Yes |
Why Should I Use Indexed Universal Life?
A 7702, 702(j), or LIRP can be an advantage for every person who wishes to accumulate wealth for retirement. It is especially useful for high-income earners who will likely max out traditional investment products or earn too much income to even participate.
As we mentioned earlier, we believe Indexed Universal Life Insurance is the best life insurance product for accumulating wealth and would be the best solution for your 7702 life insurance.
To determine whether Indexed Universal Life insurance makes sense for you, we recommend that you review the 7702 plan pros and cons of LIRP’s in order to make an informed decision.
7702 Plan Pros and Cons
Advantages of Using Indexed Universal Life for Retirement PlanningCertainly, with any investment or insurance product, there are disadvantages to consider and compare with the advantages. Disadvantages are typically based on your circumstances rather than a defect in the product.
In Conclusion
If you are considering an alternative investment product because you are unsatisfied with the retirement products you are currently using or you are concerned about your tax-liability during your retirement years, a 7702 retirement plan using an Indexed Universal Life policy may be the alternative that will best meet your needs.
Frequently Asked Questions
Why would I consider an IRS 7702 plan?
You can use a 7702 plan to accumulate wealth over time that can be used as a supplemental stream of income during retirement. You can, however, take money from your plan via policy loans without any tax consequences.
What is a 7702 Plan?
A 7702 Plan is a marketing term that insurance companies and advisors use to market insurance policies that are primarily used to accumulate wealth that you can access on a tax-free basis. It’s likely that life insurance marketing managers prefer terms like 7702, 702(j), or LIRP so the product being offered does not appear at first look to be a life insurance product.
What kind of life insurance works best in a 7702 plan?
Any type of life insurance that will accumulate cash value can be used for a 7702 plan. If your concern is about earnings, tax-free withdrawals, value protection, and a guaranteed death benefit, Indexed Universal Life will be the better solution.
Does the govenment regulate a 7702 plan like they do with an IRA?
Since your 7702 is funded using life insurance, the constraints that are placed on an IRA are not present and the tax liability typically doesn’t apply.
Is the 7702 plan Suze Orman or Dave Ramsey approved?
