A 702(j) plan is not a retirement plan at all — it’s a life insurance contract. It’s defined under Section 7702 of the United States Code (hence the name), which states that for a financial product to qualify as a life insurance contract, it must pass one of two tests:
The cash value accumulation test makes sure that the cash value of the insurance policy — all of the money that you’ve paid, plus earnings — does not exceed the present value of all future payments on the policy. (“Present value” is what an amount of money in the future is worth in today’s dollars, factoring in the expected rate of return.)
The guideline premium test limits the amount of money that can be paid into an insurance policy relative to the corresponding death benefit.
If it passes one of these tests, the financial product can be taxed as life insurance rather than as an investment. That means the monthly premiums you pay can grow tax-deferred and be accessed tax-free via policy loans.
It also means the beneficiary can receive the death benefit free of income taxes.
The Benefits of a 702(j) Plan
How your 702(j) will benefit you depends on the challenges you are attempting to overcome with your traditional retirement products.
Typically the complaints from most individuals trying to accumulate the wealth needed for the retirement lifestyle they are shooting for are eliminated when you deploy a 702(j) built with indexed universal life insurance.
Your wealth is accumulated on a tax-deferred basis
You can withdraw cash anytime without being subject to taxes and penalties
No annual cap on premium payments (contributions)
Provides a tax-free death benefit to your beneficiary
No minimum distribution requirement at 70 ½
Retirement income (taken as loans against the cash value) is not taxable
Since the insurance policy will have a floor rate that is not less than zero, the policy’s cash account will not lose money as a result of a down market.
The 702(j) allows you to invest in the market without actually being in the market
Disadvantages of a 702(j) Plan
If you borrow from your policy, however, and don’t repay the loan while the policy is in force and you’re alive, investment gains on top of what you paid. However, what you borrow could become taxable, and as such a lone, when you die.
This will be paid off from the policy’s death benefit, the amount your beneficiaries receive from the death benefit can be reduced or even eliminated. Also an interest could accumulate on an outstanding loan balance.
Also, much of your premium not used for the policy and not put into build your cash value can be consumed by high commissions and fees.
702(j) Plan vs. 401(k) and IRAs
There is no way a 702(j) plan – again, an insurance policy – is a better means of saving for retirement than an 401(k), even though it sounds like a similar product.
That’s because in most cases an employer offering a 401(k) plan also matches with a certain ratio an employee’s contribution to their own plan.
Also, making contributions to an IRA or 401(k), while there are limits, can be tax-deductible. And the growth can be tax-free on a Roth IRA.
What Is a 401(k) Plan?
Unlike a 702(j) Plan, which is really a whole life insurance policy, not a plan at all, a 401(k) plan is tax-advantaged, and has defined contributions offered by employers to employees. Like a 702(j) plan, the 401(k) is named after a subsection of the Internal Revenue Code.
Workers contribute pre-tax dollars to their 401(k) plan through automatic withholding, and employers can match some or all contributions.
The capital gains on investments in a 401(k) aren’t taxed until the employee withdraws the money, usually after retirement.
However, in a Roth 401(k), withdrawals can even be tax-free.
What Is an IRA?
An IRA is an Individual Retirement Account.
A traditional IRA allows individuals to put money aside from their pre-tax income into investments that can grow with taxes deferred.
When a 702(j) is a Good Fit
This type of plan tends to work best as a retirement strategy for individuals who have maxed out other investments, such as a 401(k). It can also be a good fit for those who are concerned about taxes during retirement.
“As your income increases during retirement, so does your tax liability,” says Robert Chewning, managing director of wealth insurance services at Wells Fargo.
Individuals with an income of $250,000 or more may benefit most from a 702(j), due to the amount that can be contributed into the plan and the tax breaks it provides on withdrawals.
“702(j)s work best with higher-income individuals,” Fried says. “If you’re not going to be in the upper tax brackets in retirement, it diminishes the value of a 702(j).”
If you’re looking for a retirement plan, a 702(j) plan isn’t for you. It’s a life insurance product that some salespeople try to sell as a retirement plan, but there are better options, like a 401(k) or an IRA.
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