Should I Set Up a 7702 Plan?

If you think that your Social Security benefits will be sufficient for you to live on in retirement, think again. And regretfully, 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 Same.

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 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.

Section 7702 of the Internal Revenue Code specifies what the IRS considers to be a legal and legitimate life insurance contract and defines how life insurance contracts will be taxed. Section 7702 only applies to insurance contracts issued after 1985.

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.

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.

 

What type of Life Insurance Is Used for a 7702 Plan?

 

Any type of life insurance that will accumulate cash value can be used for a 7702 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.

 

Features/BenefitsIULTraditional
Market VolatilityProtectedExposed
Contribution LimitsNoYes
Annual Income LimitsNoYes
Early Withdrawal PenaltyNoYes
Tax-Fee DistributionsYesNo
RMDNoYes

 

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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.

To determine whether Indexed Universal Life insurance makes sense for you, we recommend that you review the pros and cons of LIRP’s in order to make an informed decision.

 

 Advantages of Using Indexed Universal Life for Retirement Planning 

 

No Contribution Limits
Unlike the IRA or Roth IRA which have contribution limits of $6,000 annually or $7,000 if you are age 50 or older, there are no limits placed by the IRS on Indexed Universal Life Insurance.

 

No Early Withdrawal Penalties
With traditional retirement plans like the 401(k) or IRA, there are substantial penalties if you withdraw money prior to age 59 1/2. There are no early withdrawal fees or penalties with Indexed Universal Life insurance.

 

No Required Minimum Distributions
The IRS requires all employees who have contributed to employer-sponsored retirement plans to begin taking required minimum distributions during the year you turn 70 ½ and every year thereafter before Dec 31st of the year. There is no RMD requirement for Indexed Universal Life policyholders.

 

No Distribution Tax Liability
Distributions from employer-sponsored retirement plans and individual IRAs are taxable which means a large share of your retirement fund will be taken by the IRS, however, distributions from your Indexed Universal Life insurance are taken as loans and therefore not considered income by the IRS.

 

Guaranteed Tax-Free Death Benefit
Since an IUL is a life insurance product, the policy provides a guaranteed death benefit that is paid to your beneficiary free of any tax liability.

 

 Disadvantages of using Indexed Universal Life (IUL) for Retirement Planning 

 

Certainly, 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.

 

Earnings Cap
The insurance company will have an earnings “cap” that states the maximum amount of interest they will pay at the end of each reporting period. This cap will have an impact on the interest that you can earn when market returns are unusually high. The cap is offset, however, by the “floor” in the policy which states the minimum amount of interest that can be earned at the end of a reporting period. For example, if your “floor” is 0% and the market loses 8%, your account will not be affected by the losses in the market.

 

Mortality Charges
There are certain expenses like mortality and insurance expenses associated with your IUL that will increase as you get older. These expenses are based on the death benefit in the policy. When your policy is set up correctly by using the lowest death benefit possible, these expenses can be minimized.

 

Surrender Charge
Most IULs frontload their sales fees by spreading them over the first 10 to 15 years. If you decide to cancel your policy early, these fees will be deducted from the refund of your cash value. This is known as a surrender charge.

 

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, an Indexed Universal Life policy may be the alternative that will best meet your needs.

 

To make a safe and informed decision about any insurance product, contact the professionals at Ogletree Financial Services. To get the necessary information about indexed universal life insurance, you can complete the form on the left to get immediate information or contact an insurance professional at 1-800-712-8519.

About Doug Mitchell
About Doug Mitchell

Doug Mitchell, CLU holds a BA degree in Finance from Auburn University as well as having obtained a Chartered Life Underwriter (CLU) designation from The American College in Bryn Mahr, PA.  Doug has spent over 20 years in the life insurance industry and has also held licenses to sell securities, long-term care insurance, home and auto insurance.  For two years, Doug served as President of the Auburn Opelika Association of Financial Advisors and has been a member of the Million Dollar Round Table.  He obtained Life Millionaire status at Horace Mann Insurance Company and was awarded the Life Agent of the Year Award.  Later in his career with New York Life he was an Executive Council Member.  Doug currently serves as President of Ogletree Financial, a life insurance marketing organization with over 1000 life insurance agents.  Today, Doug’s main focus is servicing 1000s of policyholders and growing his agency through the reach of www.insurancequotes2day.com.

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