Several years ago, (we’re a little fuzzy on the details as to exactly when) someone somewhere within the insurance industry made a fascinating discovery, which gave way to something referred to as a 7702 Plan.
What might this fascinating discovery be? A tax loophole? The introduction to a new financial product that would bring salvation to us all?
No…not even close. Instead, this very creative individual made a half correct observation about how things get named after Internal Revenue Code (IRC) and decided to make their very own special financial savings vehicle, the 7702 plan. So what is it? That’s the point of today’s post.
A 7702 Plan is Not All That Exciting
Allow me to deflate the big balloon of anticipation, now. It’s simply a life insurance contract. In truth, there is no such thing as a 7702 plan. But, to be fair, there’s also technically no such thing as a 401k plan. The name is a colloquialism, which is in reference to the IRC that establishes the particulars of the plan.
IRC 7702 speaks to the taxable implications of life insurance contracts (tricky tricky). You see, some people feel the need to further inflate importance of an idea.
So, if we refer to selling life insurance for cash value purposes, calling it an official “plan” like 7702 Plan (because it sounds so damn cooler and exclusive) there are people (you know who you are) who will be more apt to jump on board (marketing is an awesome beast).
But is it Legal?
Here’s the issue, unlike IRA’s and 401k’s, which also are not themselves legally defined “plans” as far as actual legislation is concerned, both require the establishment of an account (a custody or trust account) to manage the funds. That account is what gives the products their tax benefits.
With life insurance, the product itself contains the benefits, there is no special “account” per se. Legally speaking, no, there’s likely nothing flat out illegal about referring to the ownership of life insurance to make use of its cash value features as a 7702 plan.
However, based on the limited amount of personal finance knowledge people in general tend to have (agents/brokers, registered reps, and IAR’s very much included) this is one of those areas where mischievousness has a lot of leverage and advantage.
This being said, the pendulum can swing both ways.
Just because an account is a 401k, IRA, et. al, doesn’t in point of fact make it a good idea. To be equally demeaning, all you are doing there is establishing a custody or trust account, and paying the custodian or trustee fees to hold onto your assets. The account has tax favorable benefits so long as it complies with the appropriate IRC.
Now, it’s correct to point out that there is a difference in so far as the official establishment of that account. The custody or trust account is required for the other accounts that are sometimes referred to as “qualified” (though this itself is a bit of a misnomer as a lot of people refer to IRA’s as qualified, which is incorrect since qualified is a reference to the Employee Retirement Income Security Act–ERISA).
Not Illegal, but not Exactly Legitimate
7702 Plans are more a marketing angle, but then again so isn’t everything else. The problem is more in the way agents present the plan. There are a collection of agents (and insurance companies) that have embraced the idea of talking people into liquidating their IRA’s in order to fund their “7702 plan.”
While I won’t categorical declare this wrong, I’m going to say that it’s rather hard to think of fact patterns that would make it a good idea.
It’s fine to point out that cash value life insurance has certain tax favorable benefits under IRC 7702, and that those benefits are hugely beneficial, especially for those whose incomes place them far beyond Roth IRA eligibility (yes the Back-door IRA method works, but $5,000/year for someone who earns over $100,000/year sort of makes all IRA’s somewhat useless).
But, when someone starts pitching the sale of life insurance as the establishment of a 7702 Private Plan, a line has certainly been crossed. The benefits exist, and they are huge, but this sort of marketing gimmick is what gets us in trouble and makes everyone’s life more difficult.
A Little Finger Wag at the Industry
Again, we’re not exactly sure who to blame for the origination of this idea, but we’ve seen many of examples of agents and companies embracing the idea (I once received an illustration to review for a guy from Northwestern Mutual that had “7702 Plan” displayed on the cover page). For a while, a lot of agents where hawking Indexed Universal Life as the 7702 Plan (after all it had something to do with the stock market) and we wonder why FINRA and the SEC want to regulate these products. The idea of marketing insurance in this way was someone’s really creative, but really bad idea.
There have been a lot of creative marketing pitches out of the insurance industry. From magically vanishing premiums, to whole life is a 401k plan, to 7702 plans. But please note, if someone approaches you and starts to “recommend” that you move to a 7702 Plan, best to shake your head and chastise them for the ridiculousness, then shoot us an email.