A 702(j) retirement plan is a permanent life insurance policy that may provide tax-free income in retirement. How does it compare to other investment options, and who can benefit the most? Here’s what you need to know.
Permanent life insurance policy
Most of us are familiar with term life insurance because we specifically purchase a 10, 20, or 30-year policy. When we say permanent life insurance policy, the only difference is — as you may guess — the policy does not have an expiration date. More importantly, it offers a death benefit and cash value. The former (of course) means your beneficiaries receive money when you pass away. The latter, though, is a separate savings option that may be accessible to you while you’re alive. And it can be an essential tool within your retirement plan.
How does a 702(j) plan work?
Now that you have a brief understanding of permanent life insurance let’s get back to 702(j) plans. You may also hear them called 7702 accounts because they are lifted from Section 7702 of the Internal Revenue Code.
Here’s how they work.
You start by paying into the policy for a certain amount of time. You’ll pay premiums but can also put in additional cash, which is referred to as overfunding. This is what makes the plan attractive to some investors — because overfunding is what creates the real cash value.
The goal is to accumulate enough cash in the policy to pay its cost and generate a tax-free income in retirement.
Is it a better option than a 401k or IRA?
401k’s and traditional IRA’s provide you with an initial tax break, as any deposit you make — including an employer match — is tax-deductible. The 702(j) does not have that benefit because any investments made into an insurance policy are paid after-tax.
So you’re paying taxes in the beginning. But the 702(j) benefit lies in withdrawals as you likely do not have to pay taxes when taking the money out (assuming you’ve met all of the guidelines and requirements). You also have the added benefit of no caps, meaning there is no limit to how much you can invest in a 702(j).
So, which is the best option? Generally, it makes mathematical sense for people to fully fund their 401(k), IRA, and Roth IRA accounts before purchasing a 702(j) plan. You don’t want to miss out on the employer match (free money) or tax benefits a 401k and IRA can offer.
Who can benefit from a 702(j) plan?
The real value of a 702(j) plan comes when you overfund the account. And you may have guessed, to be able to overfund it, you’ll need quite a bit of money.
That said, 702(j) plans make the most sense for people who make a significant six-figure or greater salary, or for people who have maxed out their 401k. If you cannot achieve the tax-free retirement payment level, you’re not taking full advantage of the plan’s opportunities. Meaning, it’s likely not the best investment vehicle to get you to a fruitful retirement.
702(j) plan risks
Even if you are in the top 1% and can afford to invest in a 702(j) plan/7702 account, there are risks to be aware of. For starters, if you don’t repay the loan, your investment gains could become taxable. Interest may be charged on loan balances, and you’ll likely have commissions and fees to pay.
Let’s not forget you’d be missing out on a potential employer match to your 401k (assuming that benefit is available to you). Plus, tax deductions that other investment options can provide.
Speak with an advisor
702(j) retirement plans are tricky and often criticized, but they shouldn’t be written off. If you have the money to invest and are interested in strategic ways to make your money go further in retirement, schedule an appointment with one of our licensed advisors.
We’re happy to discuss further the pros and cons of a 702(j)/7702 account to see whether or not the product is a good fit for you. We’d also appreciate the opportunity to find other investment options that you may be interested in.