The 7702 plan is in the Internal Revenue Code (IRC) under section 7702. The section is an insurance policy that you can use for certain tax benefits. There are tons of 7702 plan pros and cons which we will discuss below.
The 7702 plan is an insurance policy with a cash life value. It means that the policy has a cash benefit value apart from the death benefit.
Insurance companies use the term 7702 for marketing purposes with insurance policies that help accumulate wealth. The 7702 policy allows owners to enjoy benefits without paying taxes which makes them high in demand.
Differences Between 7702 Plans and Retirement Funds
Although most people tend to use the two terms together for tax reduction, there is a certain difference between them. Insurance experts claim that you should not use the 7702 plans as a retirement plan.
However, owners can use them to enhance an already existing insurance plan for charity or future use. The 7702 plan became an insurance policy because people were miscuing them. Most people started utilizing the amounts from 7702 plans for business investments while evading tax.
How Does It Help?
When a person invests in this kind of insurance policy, some amount goes to the cash value while the other goes to the death benefit. This helps the policy owners make more wealth at the end of the insurance policy.
People started investing in these policies because of the several benefits they offer. To name a few, these insurance policies can help you reduce your tax amounts and save money.
This way you can accumulate your wealth as a death benefit without fearing tax deduction. Your beneficiaries can get the full amount for the 7702 plan as a death benefit.
The big question is why someone would buy a 7702 as a retirement plan while they can simply buy it as insurance.
Requirements for 7702 Plan
There are two tests that you need to go through when getting an insurance policy. One is the cash value accumulation test and the guideline premium and corridor test (GPT). It is alright if you do not know what this means because we will help you out. Let us take a look at them briefly
Cash Value Accumulation Test
The cash value accumulation test focuses on the cash surrender value of the contract. It cannot be higher than the net single premium needed to fund benefits in the future.
It means that the amount a policy owner could get from an insurance policy cannot be greater than the amount a policyholder would pay to get a policy with a lump sum amount. Thus, sets the max policy cost as the boundary for the payment.
The Guideline Premium and Corridor Test
The Guideline Premium and corridor test explains that the sum of the premium that a policy owner pays cannot exceed the value for the guideline premium. This limits the total amount an insurance policy owner would pay for the insurance benefits
If a policy owner fails to meet any of the above-mentioned requirements, the contract qualifies as an ordinary income of the same year.
Therefore, the owner loses all the tax benefits and favors. Let us take a look at the pros and cons of the 7702 plan, for better understanding.
Pros Of 7702 Plan
No Contribution Limit
The IRA or the Roth IRA may have an annual contribution limit of $6,000 or a maximum of $7,000. However, if you are 50 or above, there is no limit to the contribution you can make. This way you can add more amount as a contribution every year accumulating a higher wealth amount at the end.
No Early Withdrawal Penalty
Other retirement plans like 401 (k) or IRA have penalties if you try and withdraw money before reaching the age of 59.
However, there is no penalty on withdrawing your amount before it with a 7702 plan. You can choose to withdraw your money at any point without worrying about the withdrawal penalties.
No Minimum Distribution Requirement
Unlike other policies and retirement plans, the 7702 plan does not have an RMD requirement. Contrary to this, every person who owns an employer-provided insurance plan needs to take minimum distributions during the year you turn 70 ½ (31st December of every year).
No Tax Liability on Distribution
Most employer-provided insurance plans have a tax deduction. However, the 7702 plan does not require you to pay any tax amount. It is because these amounts count as loans. Thus, you are not liable to pay the tax for them. Tax reduction is perhaps the biggest reason why these 7702 plans are so popular.
Tax-Free Death Benefit
The 7702 qualifies as an insurance policy. Therefore it has a death benefit that the beneficiaries can get tax-free. You wouldn’t have to worry about your beneficiaries losing money to tax reduction through this plan.
Cons of 7702 Plan
The 7702 plan has its perks and its drawback. However, the disadvantages of the 7702 plan are circumstantial. It all depends on the kind of 7702 plan you take and the amount you pay for it. Therefore, you must know where you stand.
The 7702 plan also has the following disadvantages:
There is a cap on the maximum amount of interest that an insurance company will pay at the end of every reporting period. The earning cap has a profound impact on the total amount you get because the market returns tend to stay high in most cases.
It also has a floor amount which represents the minimum amount you can earn by the end of your reporting period. For instance, if you have a floor amount of 0% and the market loses 8%, it will not affect your interest rate. So, make sure you keep an eye on the earning cap the next time you go for a 7702 plan.
There are certain mortality charges that you need to consider when you buy the 7702 plan. These expenses tend to increase as you get older. You can determine the mortality charges by calculating the death benefit that your insurance policy provides you.
The best way to deal with this is to choose an insurance policy with the least death benefit possible. This way, you won’t have to pay extensive amounts for mortality charges.
The plan providers have a sales fee which they tend to increase every year. If you decide to withdraw your plan amount during the year, they will deduct that sales amount from the plan. The deduction will have an impact on your cash value making things more difficult for you.
Anyone who buys a 7702 plan will have to pay large amounts of money to the insurance agent as commission. You need to pay 6-7% of the amount on each deposit you make. It is similar to the load on a mutual fund.
There are other anonymous contract fees, mortality and expense, admin fees, and investment options fees that all come together to make it a considerably large amount. All of this can cost you hundreds and thousands of dollars on your wallet each year.
Is The 7702 Plan Worth It?
It all comes down to that simple question: is the 7702 plan worth investing in? Unfortunately, there is no absolute answer for it.
It all depends on what you aim to achieve with the 7702 plan. You can save tons of tax money and use it for other purposes by withdrawing or you can keep it for your beneficiaries.
However, keep in mind that these 7702 plans can cost you a lot. Therefore, it is best to consult an insurance professional before you decide to buy one of these policies. These professionals can help you understand things better and suggest the best strategies.
In A Nutshell
If you are unhappy with your retirement plan, you can always choose a 7702 plan. They will surely help you save tons of tax money and benefit your beneficiaries later in life.
We hope that these 7702 plan pros and cons help you understand things better the next time you want to invest in it. You can reach us for more information about the 7702 plan or other insurance policies.