Every investor wants to maximize returns and minimize losses. So it’s no surprise that there’s been buzz recently about a retirement account, often called a 702, that promises to help achieve that goal, paying a guaranteed return of up to 60 times the standard bank account — tax-free.
NerdWallet’s Ask an Advisor forum has seen its fair share of inquiries about such an account, sometimes referred to as a 7702 or 702(j). People want to know how to open one, what it is and whether it should replace their 401(k) or IRA.
It’s clear why the description of this account, currently being promoted in flyers and books by an organization called Palm Beach Research Group, is catching interest. The group calls it a way to “retire with an extra $4,098 per month, tax-free.” It says that this is an account used by “Washington insiders” and billionaires, name-dropping Bill Gates and Warren Buffett. The message: Don’t you want to be in that crowd?
As it turns out, you probably don’t. Advisors on NerdWallet’s forum, for instance, have consistently chimed in that this isn’t the holy grail it is purported to be. (Palm Beach Research Group, which publishes various types of financial advice, didn’t respond to NerdWallet’s request for comment.)
In fact, it isn’t a retirement account at all; it’s a life insurance policy. The name, like IRA or 401(k), comes from a section of the Internal Revenue Code — in this case section 7702, a portion that regulates life insurance contracts. The intention, it seems, is to put a tax-code name on a permanent life insurance policy in an effort to associate it with retirement plans.
Understand permanent life insurance
Permanent life insurance policies are designed to provide coverage for the rest of your life, and also contain a cash value component. Part of your premiums go to this account. Over time, the cash value account builds up, and you can borrow against it.
A 702 is sold as a permanent life insurance policy that you overfund by paying higher than normal premiums, more than is necessary to keep it in force. You then borrow from the policy’s cash value during retirement, paying no taxes because such loans are tax-free. That’s why those who sell 7702s tout them as a way toward a tax-free retirement: The loans generally do not need to be paid back while the policyholder is alive. They’re repaid out of the death benefit after the policyholder dies.
Evaluate the risks
But taxes shouldn’t be your only consideration when retirement planning. “It’s important to evaluate this or any retirement savings option in the context of your overall situation, rather than just fixate on the potential tax savings,” says Roger Wohlner, an independent financial advisor and blogger.
This 702 strategy has many risks. If you don’t pay back the loan, any investment gains borrowed could become taxable. If you die while a loan is outstanding, it will be repaid out of the policy’s death benefit, reducing or even eliminating the amount your beneficiaries receive. Interest may also be charged on any outstanding loan balances. And much of the premium you pay into these policies is eaten up by high commissions and fees.
Compare to retirement plans
Putting your money into a permanent life insurance policy as a means to save for retirement could also mean diverting assets away from a 401(k), where you may get an employer match, which actually is a 100% guaranteed return on your investment. It could mean losing out on the tax deductions you’d get by instead making contributions to an IRA or 401(k), or on the tax-free growth offered by a Roth IRA. And it may mean missing out on at least some investment growth, because while these contracts sometimes guarantee you won’t lose principal, they may also put a cap on returns, which means you wouldn’t capture some of the growth brought by big market years like 2013.
“Some insurance agents love these, but it’s an expensive way to invest and accumulate assets,” says Wohlner. “I’m not saying it’s a scam, but it’s nothing new. Call it whatever you want — you can put boots on a pig, but it’s still a pig. People should go into it with their eyes open and compare it to other options.”
What other options might those be? The aforementioned 401(k) and IRA, to start. High net worth individuals — frequently the targets of 702 sales pitches — who have maxed out those accounts can move on to taxable accounts; those who own their own businesses could start a pension plan.
The bottom line
If you decide you want to include life insurance as part of your retirement planning, purchase it from a trusted broker (and ideally, a fiduciary) and be sure you’re aware of all fees. If you don’t understand something, you shouldn’t buy it — or you should at least consult a financial advisor about whether it’s the best choice for you. There are no get-rich-quick ways to fund your retirement, other than hard work, careful planning, and early and consistent saving.
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