702(j) retirement plan is not a retirement savings plan like a 401(k) plan. It’s not an investment vehicle. It’s a life insurance contract governed by Section 7702 of the U.S. Code, which lays out the rules for life insurance contracts. Specifically, a 702(j) retirement plan is a permanent life insurance policy. This means that if you pay your premium, you’ll continue to be eligible for the life insurance benefit. This contrasts with term life insurance policies that are only eligible for a certain period. The insured pays extra premiums each month, beyond that which covers the life benefit, which increases the value of the policy, and later can be borrowed after retirement.
Using a life insurance policy to supplement retirement income isn’t a new invention. Permanent life insurance has been available and used for decades. Generally, a 702(j) retirement plan grows as tax-deferred and can then be accessed tax-free via policy loans. The 702(j) retirement plan does have its drawbacks. High fees and inconsistent investment returns make a 702(j) retirement plan a questionable investment strategy.
Pros & Cons of the 702(j) Retirement Plan
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Most fiduciaries, individuals who are required to act in your best interest, should fully fund other retirement vehicles first, such as a 401(k), 403(b), IRA or Roth IRA before the 702(j) retirement plan. There is generally more flexibility in your investment options, lower fees and more transparency with these accounts. Investment advice should come from a fiduciary if possible.
A 702(j) retirement plan can make sense for a select group of people: those who have maxed out their 401(k) and IRA and are searching for a place to put money where it will grow tax-free, for instance. Since it’s technically life insurance, it’s taxed as life insurance rather than 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 702(j) retirement plan shouldn't be used as a replacement for retirement accounts but should instead be considered a life insurance policy that can be borrowed against if needed. A 702(j) retirement plan might make sense for a wealthy taxpayer who needs somewhere to stash cash that will not affect eligibility for certain aspects of Medicare and does not count as income when considering what portion of Social Security benefits are taxable.
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