7702 Retirement Plan? There’s No Such Thing

A growing number of insurance companies and independent financial advisors have been selling “7702 Plans,” sometimes referred to as a “7702 Private Plan,” for retirement.
On Google alone, a query for “7702 plan” results in almost 1.5 million pages of matches.

This is fascinating, largely because there is no such thing as a 7702 plan.

A vehicle for selling life insurance

If you go to one of the thousands of websites, you’ll find a description of something that sounds like a 401(k) or IRA, but is based on life insurance. The page will explain that unlike traditional retirement plans like 401(k) and IRA accounts, “life insurance retirement plans” have no limit on contributions or size, and no requirements for withdrawals at a certain age.

A 7702 is not a “retirement plan” as most people understand retirement plans. Rather, it’s another name for a life insurance policy, often variable universal life.

35456130I first learned about the term “7702 plan” in a Starbucks in Palo Alto a few months ago. Elliot Shmukler (our VP of Product) and I were walking to Starbucks in Palo Alto, discussing Wealthfront. Unsolicited, a woman interrupted us and asked if we did “7702 Plans”?  It turned out she was a professional financial advisor, and she proceeded to give us a helpful “tip” to grow our business: sell 7702 plans!

Insurance agents and financial advisors are using this tactic to aggressively market expensive life insurance policies.  No thanks.

Marketing gimmick: Mimic the 401(k)

There are very few people who actually cite lines of tax code like citations from Shakespeare, but there is one section of the tax code that is famously quoted: the 401(k). Yes, there is actually a “subsection 401(k)” of the Internal Revenue Code, dating back to 1978, that allows corporations to provide tax-deferred retirement accounts to their employees.

The Internal Revenue Code also has subsection 7702. It’s the section that discusses the tax implications of life insurance contracts. Some advisors are using the construct of the 401(k) name to relabel life insurance policies as 7702 plans, thus associating them with the concept of retirement plans.

“7702 Plan” is just a marketing term used to allow an existing set of life insurance products to borrow some of the credibility from the IRA and the 401(k). Linking life insurance policies subversively to 401(k)s makes them easier to sell. It doesn’t make them retirement plans.

It’s not an account, and it’s not a plan

It’s important to note that this isn’t a post about how bad whole life insurance is.  (Andy Rachleff recently authored Why Whole Life Is A Bad Investment.) Nor am I arguing that whole life insurance (and universal life and annuities) do not have tax benefits that can be turned to your advantage. As a society, we have chosen not to tax death benefits.

A life insurance policy is a contract between you and the company.

What life insurance clearly is NOT is a retirement plan like a 401(k). The marketing of whole life insurance policies as a form of savings and investment is wholly the creation of the insurance industry.

A 401(k) or an IRA is an account that holds assets that you own, but an institution has on deposit for you. There are extensive regulations and definitions around companies and organizations that are allowed to hold the accounts and manage the relationship with you.

A life insurance policy, in contrast, is a contract between you and the company. At its base, the policy is an arrangement between you and the life insurance company. The terms are set at the beginning and generally are highly favorable to the insurance company, and you can’t change them as your life evolves.

Huge commissions lead to aggressive sales

Leveraging historical tax treatment for life insurance policies, the industry has continued to generate a never-ending set of incredibly profitable products, allowing them to pay enormous commissions to the people who sell insurance products to individuals. It’s not surprising to see an aggressive tactic like labeling these products “7702 Plans” and “7702 Private Plans.”

The high profitability of these products gives the incentive for a wide range of financial services to sell these products. A product that is highly profitable for an insurance company is often a poor deal for you.

Don’t be fooled

If you are approached by someone touting the advantages of a 7702 private plan, know that they are (1) talking about whole life insurance, and (2) that they are using a relatively new, and fairly aggressive sales technique.

At Wealthfront, we recommend that people who want to save for retirement take advantage of low-fee, well diversified portfolios in IRAs. Be informed, be careful and do your own research. (Take a look at our retirement section for more on this particular topic). We’re continuing to work on an analysis of the tax benefits of whole life compared with the tax benefits of an IRA and hope to publish it in the next few weeks.

Disclosure

Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security or insurance product.  Wealthfront is not a licensed insurance agent. Past performance is no guarantee of future results.

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12 Responses to “7702 Retirement Plan? There’s No Such Thing”

  1. Kate R June 26, 2013 at 9:00 am #

    Hello fellow Stanford grad, I have to politely disagree.

    A 7702 plan is an INDEXED universal life product. You provided a link to whole life. People, get educated! Read The Retirement Miracle by Patrick Kelly. Look up indexed universal life.

    Define “retirement plan.” If it’s a vehicle that allows you to retire, then how does 7702 not qualify? Using that definition 401(k) should not qualify because nobody has successfully retired on a 401(k) they all have to come out of retirement 7 years later and work at Walmart.

    The life insurance component is what allows the 7702 to be tax free so you don’t go broke giving all your money to the government during retirement. There’s nothing wrong with having a life insurance component in your retirement plan.

    People spend 200k over their lifetime in fees on a 401(k)! Then we have to pay half the money in taxes! The 7702 is a solution to our retirement problem here.

    Adam, this article is miseducating the masses. We need this. We need 7702 ‘s. I don’t know how I would retire otherwise, I stopped contributing to my 401(k) no way was I going to retire on that thing.

    • Adam Nash June 26, 2013 at 1:27 pm #

      Hi Kate,

      We actually agree that 401(k) plans can be problematic for people, particularly if you work for a company with expensive or inappropriate investment options. In fact you can see our opinion of most 401(k) plans here:

      Why Your 401(k) Plan Sucks

      Describing a particular investment vehicle, whether it’s gold, rental property, or an insurance product as a “plan” is a misnomer at best, and at worst, an aggressive marketing technique. Picking a number from the tax code (7702) to give it the air of validity is further evidence of this type of aggressive technique. The fees, by the way, that you’ll pay in your 7702 are incredibly high.

      The performance and fees associated with these insurance products compares extremely poorly to more serious alternatives: traditional & Roth IRAs or normal taxable investment account, invested in a diversified low-fee, tax-efficient portfolio.

      Adam

  2. Dan Snow July 13, 2013 at 9:03 am #

    You talk about how dangerous these plans can be, but every financial tool has its place. 401k plans were never meant to become the mainstream and main component of the retirement and asset accumulation plan.
    What I do agree with in your article is that being deceptive to sell life insurance is a very bad thing and should be avoided. Deception is never good.
    Advisers who sell IRAs and 401k plans to employees are just as deceptive. Most people have no idea what they’re money is invested in or what to even look for when investing in their futures.

    Education is what’s needed.

    • Adam Nash July 13, 2013 at 12:20 pm #

      Dan,

      We’ll have to disagree on the idea that “every financial tool has its place”. It’s just not true. There are a wide variety of financial products and tools out there, but not all of them are in the best interest of clients. We’ll agree on the fact that positioning these life insurance products as “accounts” or “plans” is an aggressive sales technique. These commission-based salespeople are not comparable in intent or compensation with human resources professionals advising employees on 401(k) plans, or SEC-regulated brokerage firms with IRA accounts.

      Education is always valuable and needed.
      Adam

  3. Charles P July 13, 2013 at 11:46 am #

    Adam, I’m going to have to take you to task here. You’re making some disingenuous statements, I presume based on lack of knowledge.

    First, let me point out that _average_ 401k fees run into the 3.5-4.5% range, net. That’s well-documented at this point. Don’t take my word for it – CBS, Bloomberg, Time, Newsweek – this has been repeatedly and independently covered. And that fee rate is based on the amount of money you have in there. $1000 – you’re looking at $35 in fees each year. $100,000, you would be looking at $3500 in fees. Do well, get up to $500k, and you’re looking at over $17,000 in fees. And there’s no guarantee of performance.

    And that guarantee matters. Simple reality. In 2008, on average 401k account holders lost 37% of their assets. Over one third. By the end of 2012, based on S&P performance, they’d barely made it back. So that’s five years (2008-2012) of virtually zero net returns.

    So, 7702/LiRP fees. The assertion “they’re incredibly high” depends entirely on what timeframe you’re looking at. If you look at the first few years, you know what, you’re right. They are high. That’s because the fee structure is tied to the value of the insurance, not the size of the contained investment. So let’s say you have $200k in insurance, fees on that might be $4000/year for the first ten years. Yep, that’s very high.

    And then after the first ten years, the fee structure drops dramatically (down to about $1500/year) and pretty much stays there. So let’s say you start with $10k in funds in there, growing to those higher numbers (above) over time. So at first you’re looking at high fees. By the time you hit $200k, however, you’re looking paying, what, 1% in fees? Grow it some more, and you’re under 1%.

    There’s a couple other side benefits that 7702/LIRPs have. First, look at tax treatments for 401ks, IRAs, and Roths wishing to retire prior to age 59 1/2. What happens (other than 72ts) is that you wind up paying a premium to pull that money early. LIRPs don’t have that. At. All.

    Second, there’s the “how much money can you put in” problem. I don’t have to educate you as to those limits. But for the wider audience, there’s a cap ($17,500 This year) to how much you can put in. LIRPs? No such limit. We have clients who put >$100k/year into LIRPs, because they have the ability to do so.

    Oh, and that pesky qualifying income cap for Roths? Doesn’t exist for 7702 plans.

    So, the short version? It’s _an_ option – a legitimate one, but not one that you know anything about.

    That being said, I’m in the area (San Jose) and would be happy to sit down with you and Andy and go over how they work, and what the advantages and limitations are.

    Oh, and yes, whole life does in fact suck. But if that’s what you’re basing your judgements on, you’re working with 20+ year old information. Like basing computing requirements on what chipsets Intel was shipping in 1992.

    Seriously – ping me in email and we’ll set up some time to talk.

    CP

    • Adam Nash July 13, 2013 at 12:43 pm #

      Hi Charles,

      While I appreciate the note, there is nothing disingenuous about the fact that branding life insurance retirement plans (LIRP) as 7702 plans is an aggressive sales technique designed to mislead, not inform.

      We’ll agree on the fact that most 401(k) plans are terrible. You don’t have to go to CBS or Bloomberg, Andy wrote a great post on the topic at the beginning of the year on “Why Your 401(k) Sucks”
      https://blog.wealthfront.com/401k-retirement-plan-fees/

      At Wealthfront, we’re big believers in three key ways investors can benefit themselves long term: low fees, diversification, and low taxes. So while you do a good job of highlighting the problems with *some* 401(k) plans (for example, the plan at Google is excellent), you ignore the fact that LiRP fees are incredibly high compared to a well-diversified portfolio of low cost ETFs. Combined with the underperformance of these products due to poor asset diversification and management, as well as high implicit costs for downside protection, they are a financially sub-optimal choice for most individuals compared to other products & services.

      If you would like to talk directly to go over individual situations, obviously a blog comment is not the best way to connect. Feel free to email or call Wealthfront anytime.
      Adam

      • Thomas February 14, 2014 at 10:17 pm #

        I agree with this point Adam and it is well said. In addition, I have looked at universal, variable, and equity-indexed products – how is it possible anyone can claim financial independence with these products?

        In any illustration I have ever seen for variable, universal, or indexed, the guaranteed column (which is the only one I care about in a life insurance policy, since that’s one of it’s “selling” points against investing in the market) always ends up having 0 cash value and 0 death benefit as early as 70 years old, even the middle column goes to 0 into the 80′s! The only one that doesn’t implode and has millions by that point is the current rate with low, non guaranteed fees. This column is the only one any of the agents I talked to ever looked at, to me that’s like saying “if you go sky diving your chute may open and you have a chance at a graceful landing, but the guarantee is that you’ll hit the ground and die”.

        It seems the people selling these products are either ignorant of the real guarantees, “hoping” it ends up looking like the last column and not the guaranteed one, or con artists.

        I decided to buy a whole life policy actually, for 3 reasons:

        1) it seems to me that, based on all the “google” research I have done, that term insurance is the biggest money maker for insurance companies, since 98% of them do not pay a death claim. I imagine that’s why they are so “cheap”.

        2) The whole life illustration is the only one I’ve seen that the guaranteed column still has cash value and a death benefit

        3) My thoughts are to use my death benefit to let me spend my other assets more aggressively, like annuitize a few of my investment accounts and reverse mortgage my house, something I wouldn’t do if I didn’t know for sure I was leaving a legacy for my wife and kids. I feel like these options give me much more cash flow potential then just interest only off my Investments or putting my money in muni bonds.

        Thanks for your great blog!

  4. Bill September 21, 2013 at 1:22 pm #

    First off, I would like to thank you for providing a forum where some rigorous debate can take place. Secondly, I’d like to point out that In my professional opinion IUL is a dangerous vehicle to be allocated for accumulation purposes (95% of premiums in excess of raw insurance cost go to a companies general account w/ 5% going to buy options. If a client uses the concept to SLRP in retirement during a down market year, the crediting rate is a function of these stock option performances and the policy LAPSES. This can lead a client to pay a penalty as well as ordinary income on all gains. I think that IUL’s are dangerous outside of providing pure death benefit. If you are selling them as an accumulation tool, then you should advocate that FINRA regulate them).

    Okay with that off my chest, let’s visit VUL and WL. I have a custom 6 pay whole life from one of the peer companies (after year six it is contractually paid up and not another dime is owed). The reason why I purchased the vehicle was for death benefit. I merely wanted to ensure that the proceeds of my grandfather’s estate would get passed on to my children. Of course, a minor selling point is a SLRP concept where I can pull out $3 for every dollar put in tax free. BUT, this is on an illustration provided by a company, which is a best guess!

    The VUL is most appropriate as a tool for people that have maximized their ROTH. You get some death benefit protection, but the real purpose is tax advantaged growth and tax advantaged distribution. That said, VUL’s with the lower fund fees and expenses have to be properly designed and maintained. These vehicles can easily be as dangerous as an IUL.

    Our clients should have a diversified well rounded portfolio. This should include life insurance, if you are of the belief that 2 out of 2 people will die. In my practice, we believe that utilizing a holistic portfolio of both pre-tax and after tax savings is key. There are only 3 after tax vehicles that you can use to minimize future taxes: 1) the ROTH, 2) Tax free Muni’s and 3) CVLI.

    Is it disingenuous to describe life by it’s respective tax code? I can’t speak to that, but many vehicles such as 401(k)’s & 403(b)’s are described in such a way. If there is no such thing as 7702 plans, then one might argue there is no such thing as 401(k) plans either.

    • Adam Nash September 21, 2013 at 1:49 pm #

      Thanks for the comment.

      The key to this discussion is really two things:
      1) Life insurance isn’t a plan, and it isn’t an asset class. Life insurance, fundamentally, exists to allow a large number of individuals to pool their risk, and provide better outcomes for an unpredictable, yet massive life event (death). This creates a steady flow of cash (float) which can be invested prudently and effectively for the long term, assuming decent actuarial effort. There is nothing inherent in the life insurance industry or structure that allows for better returns than large endowments or other pools of intelligent capital. This is why fees matter, and while the benefits of tax-deferred status are real, they often do not compensate for the high intrinsic fee structure of most life insurance retirement plan vehicles, as well as the plethora of creative penalties the industry has engineered for early withdrawal.

      2) Even after-tax, a low-cost passive portfolio that minimizes investment fees, trading costs and realized gains can be incredibly efficient. Add in features like tax loss harvesting, and a low-cost, after-tax portfolio can provide a better return over long periods of time than a high-fee, tax-advantaged portfolio. There is a lot of variability in individual lifestyles (e.g. what state you live in) and estate planning that can affect retirement predictions, however.

      Thanks again for the note. I’ll continue to maintain that if you run into someone selling a 7702 plan, that’s a strong signal that they are using aggressive selling techniques. Life insurance contracts are not plans, they are not accounts on deposit for you as per either a bank holding company or a brokerage custodian.

      Adam

  5. Cy Ledesma October 8, 2013 at 6:18 pm #

    So Adam what would you suggest in place of an IUL that will help me retire without being taxed when I need the money most, which is when I retire in 30 years?

    • Adam Nash October 12, 2013 at 9:51 pm #

      If your firm offers a Roth 401(k) with index fund options, I would recommend that as a start. Roth IRAs (and Roth IRA conversions) can also be attractive. Given the incredible high fees, liquidity issues, penalties, and poor asset allocation of most IUL products/services, I would recommend a low-cost, diversified, tax-efficient portfolio. The return benefits over 30 years of low fees, incremental return for an 7-asset portfolio, and the benefits of tax loss harvesting are substantial.

  6. Timothy Hider November 7, 2013 at 12:13 pm #

    Thank you sharing Adam Nash. As life insurance agent I am passionate about what I do for a living. Life Insurance is an extremely important tool to secure financial protection for loved ones in the event of untimely death. It is also an extremely efficient way to transfer wealth, and protect assets for those with estate tax problems – I know this is not the majority.

    I completely agree it is misleading to use terms like “7702 Plans” or Section 7702 Private Pension Plans when agents are actually selling cash value life insurance.

    How these policies are often sold, with excessive fees it makes helping people with life insurance planning a tough business. There are some agents who get the joke, understand how life insurance companies operate and bring objective value to clients – whether purchasing term or cash value life insurance. There are benefits to both especially when properly designed and fees are suppressed.

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