What You Need to Know About a 702(j) Retirement Plan

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

PROS

  • Guaranteed Growth: 702(j) retirement plans can contractually guarantee that accounts will grow in value every year, and they guarantee no fee increases—ever. The plans are issued by private companies that invest only 1-10% of their assets in safe, blue-chip stocks. The rest is invested in outside-the-market fixed income. That’s why these retirement plans pay, whether stocks go up, down or sideways.
  • Yearly Dividends: The 702(j) retirement plan has safer returns than stocks, options, ETFs and REITs. Dividends can be directly deposited into your account. Unlike mutual funds and most other investment vehicles, 702(j) retirement plan returns do not rise and fall with the stock market.
  • No Penalty for Early Withdrawals: Unlike a 401(k) or IRA, with the 702(j) retirement plan you have the contractual right to access your cash any time, for any reason, without penalties.

CONS

  • Life insurance Fees: The 702(j) retirement plan has fees associated with it. You have to pay for the cost of the insurance, mortality and expense charges, administration charges, annual policy fees, state taxes and the marketing expenses (commissions) that go to whoever is telling you about the plan.
  • Maintenance Fees: Fees on the 702(j) retirement plan can be high and are skewed to the benefit of the insurance company and salesman. There are administrative fees, mortality charges, surrender charges and a large upfront commission paid to the agent. Fees are extremely important to take into consideration when evaluating options for retirement because the effects are compounded over a long time horizon, and high fees and costs can cause serious harm to your retirement savings.

How to Get Started

retirees enjoying their retirement with their dog
Image via Freepik
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.

Conclusion

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.

Featured image: Image via Freepik

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