Understanding a Section 7702 Plan: Tax-Free Retirement

A Section 7702 plan might sound like a retirement plan, but in reality, it doesn’t fit into this category. Instead, this is a life insurance policy with certain tax advantages to the policyholder.

What does this mean in practice, and do I need a 7702 plan?

We’ve explained everything you need to know about the “7720” life insurance policies in plain terms – so, let’s dive right into it.

What Is a 7702 Plan?

A 7702 plan is a tax-deferred life insurance policy that builds cash value over time in addition to the death benefit. This type of life insurance is also known as a cash value life insurance policy.

So, if you’re in search of a retirement plan, a 7702 plan can be a good alternative that can provide a tax-free income stream at retirement.

The “plan” part of the name is merely a marketing term that some financial planning & insurance companies use to sell life insurance as a retirement plan alternative, comparing it to the typical retirement plans like 401 (k) or IRA. Remember: There’s no such thing as 7702 traditional retirement plans.

How Does a 7702 Plan Work?

7702 plans work like other life insurance contracts in a cash value policy – because that’s what they are. Provided that they meet certain regulations (outlined by Section 7702, hence the name), some of the premiums you pay can be used to build cash savings, while some of the premiums go to the death benefit and cost of insurance.

Therefore, 7702 plans function in the following way:

A person signs a contract with the insurance company and becomes insured, i.e., becomes a policyholder. Depending on the agreed terms, the policyholder pays premiums that go towards the funding of the cash value and death benefits.

The cash value will be tax-free while it’s growing, which is known as “tax-deferred” growth because it’s not being reduced by taxes every year. The income withdrawn form the cash value will also be tax-free. The family of the policyholder is paid the death benefit after death tax-free as well. Some also call 7702 LIRPs or life insurance retirement plans which you can learn more about here.

What Is a Cash Value Life Insurance Policy?

The cash value component of life insurance policies refers to the part of your life policy that earns interest and may be available for withdrawal in certain cases.

Life insurance policies that can qualify as cash value life insurance include:

In that sense, they differ from term life insurance. Term life insurance only provides temporary insurance coverage – for example, for 10, 20, or 30 years. As such, these policies have no cash value accumulation, and you cannot borrow money or cash out the policy for any purpose other than the death benefit.

Can life insurance policies be used for retirement and as an investment vehicle? Technically, yes, in some cases – if you borrow from your cash value, or if you withdraw it after retirement. That’s why some devious marketers call them “7702 plans.”

But the main purpose of life insurance policies is to protect your loved ones financially with the death benefit, and they should not be considered an alternative to qualified retirement plans.

What Is Section 7702?

Section 7720 is part of the Internal Revenue Code (IRC) that outlines the criteria that life insurance policies have to meet in order to retain tax benefits.

If a life insurance contract doesn’t meet the criteria of this tax code, then both the death benefits and the cash value of the policy won’t be subject to tax advantages and will be counted as taxable income.

In other words, Section 7702 of the Internal Revenue Code regulates the tax rules and how federal government taxes correlate to life insurance contracts. Therefore, section 7702 is just a tax code, and not a retirement plan.

What Section 7720 outlines are two tests that should be satisfied:

  • Cash value accumulation test (CVAT) and
  • Guideline premium and corridor test (GPCT)

Cash Value Accumulation Test (CVAT)

The Cash value accumulation test stipulates that the cash surrender value – in plain terms, the amount of money that the policyholder can receive if s/he decides to cancel a policy – cannot be higher than the sum of all future premiums that are due.

For example, if someone paid their whole life insurance in a single payment, the cash value would have to be less than the amount that was paid. In the event that the accumulated cash value is higher than any future payments, then the policy would fail this test defined by Section 7702.

Guideline Premium and Corridor Test (GPCT)

On the other hand, the guideline premium and corridor test focus on premiums paid.

More precisely, it postulates that the policyholder cannot pay more into their life insurance than the amount necessary to fully fund the death benefit. Hence, the sum of the premiums cannot exceed the insurance benefits that are the guideline premium limits.

If a “7702 plan” – that is – a life insurance coverage policy – doesn’t pass these two tests, then it’s considered taxable by the government as ordinary income.

Differences Between 7702 Plans and Retirement Plans

Qualified retirement plans, such as a 401 (k) retirement plan, are provided by your employer with the purpose of having a percentage of every paycheck paid directly into your retirement savings account.

As such, a 401 (k) enables a diversion of a portion of one’s salary into long-term investments on a tax-deferred basis. The investment income is typically subject to a tax deduction (i.e., it’s tax-free) until you withdraw the money after retirement.

Another popular type of retirement plan is IRA (an individual retirement account). It’s similar to a 401 (k) plan, but unlike 401 (k), IRAs can be obtained without an employer. Individuals who want to save long-term while enjoying a tax-advantaged status usually opt for IRAs that can be obtained through a bank, a personal broker, or another financial advisor.

An early withdrawal from individual retirement accounts – prior to age 59½ – will have certain tax implications, usually in a 10% tax penalty.

When all of the above is taken into account, it becomes clear how 7702 plans differ from retirement plans.

Unlike 401 (k) that requires no commission, 7702 is life insurance that can build cash from the premiums you pay beyond the death benefit, which is its primary purpose. While the amount can grow tax-deferred, 7702 plans are usually only backup options to traditional retirement plans.

A financial planner can help you if you decide to use 7702 plans as a backup, but be wary: Any insurance agents that are trying to sell you 7702 plans without mentioning that it is a legitimate life insurance contract – that is, a life insurance policy – should probably be viewed with suspicion.

Even if a cash-value insurance product such as whole life insurance is a good fit for your financial situation or strategy, it’s not a substitute for a retirement plan.

Get the Cheapest Life Insurance Quotes

At Insurance Geek, we generate the cheapest quotes for our customers’ life insurance plans – and we call them by their legitimate names – whole life insurance, universal life insurance, etc., – not “7702 plans.”

You can get the quotes if you use our free life insurance calculator. The only thing you need to do to calculate your potential premiums is to tell us some basic info about yourself, like your location and date of birth, and we will contact our carriers to show you what offers they have for you.

We are partnered with over 30 insurance companies, Allianz and North American being the most recommended ones for a 7702 plan.

What Type of Life Insurance Policies Is the Right for You?

Insurance Geek also offers advisory services for any insurance-related inquiries you may have.

If you’re not sure whether you would benefit from cash value life insurance policies, or you’d like a professional to review your existing policy, one of our insurance agents will gladly assist you. You’ll get an expert’s opinion and we will walk you through all of your options.

We can help you find the right life insurance company and choose the right life insurance products for you.

Can I Get a Discount?

Of course! We’ll help you score the lowest price possible.

There are a plethora of opportunities to earn a discount and save money. For example, you can get multiple insurance products – such as homeowners or auto insurance in addition to life insurance – with the same provider, or you can pay premiums upfront.

Final Words

We’ve learned today – a 7702 plan (also known as a cash value life insurance policy) is a tax-deferred life insurance policy that builds cash value over time in addition to the death benefit.

At Insurance Geek, we believe that full transparency is the key when buying any security or insurance product.

That’s why we prefer to call the so-called “7702 plans” what they actually are: life insurance.

If you want to get a better understanding of any policy features, how to find the right insurance company, and what’s the best solution for your case, don’t hesitate to contact us.

We will find you a tailored solution, and we will help you calculate the amount you would pay for life insurance or any other insurance products you may need!