Retirement planning is complicated enough, and then there are terms like SEP IRA, Roth IRA and 401(k) to contend with. There’s another obscure-sounding term that comes up in retirement-planning talk — the 702(j). It’s marketed as a retirement plan and even sounds like it’s related to a 401(k). But this plan is actually a life insurance contract.
There is no such thing as a 702(j) retirement plan — it’s a tax haven related to whole, or permanent, life insurance. Similar-sounding accounts such as the 401(k) or 403(b) plan are named after sections of the tax code regarding retirement, but section 7702 of the tax code refers to life insurance.
- What Is a 702(j) Retirement Plan?
- How Does a 702(j) Retirement Plan Work?
- How To Spot a Good 702(j) Retirement Policy
- What Are the Drawbacks of a 702(j) Retirement Plan?
- How Does a 702(j) Compare With a 401(k), IRA and Other Retirement Plans?
- Are 702(j) Programs a Scam?
- Other Ways To Save for Retirement
- A 702(j) vs. Traditional Retirement Accounts
A 702(j) retirement plan is a marketing term a financial advisor or insurance broker uses to sell permanent life insurance. Using the word “retirement” with a 702(j) is misleading — “infinite banking” is a better term. The Infinite Banking Concept was developed by Nelson Nash to encourage others to “become your own banker” by purchasing and contributing to permanent life insurance to self-finance major purchases like a home.
The tax advantages of a 702(j) are trifold:
- You can borrow money against your policy tax-free.
- Interest earned on the contributions you make are tax-deferred.
- Your beneficiary will receive a death benefit free of tax obligations.
But is the 702(j) a good investment strategy? Keep reading to find out.
A 702(j) plan works differently from an actual retirement plan. An individual retirement account such as a Roth or traditional IRA or an employer-sponsored 401(k) is designed to help you save for retirement. All 702(j)s are life insurance contracts that allow you to loan yourself money tax-free. Here’s how a 702(j) retirement plan works:
- You purchase a whole life insurance policy.
- You pay a monthly premium to increase the cash value of your policy.
- You can borrow the money as a tax-free loan.
Whole Life or Permanent Insurance
Term life insurance covers you for a limited time — usually 10 or 20 years — by paying your beneficiaries a death benefit should you pass while still insured. Permanent life insurance, also known as whole life, has no coverage end date. As long as you continue to pay your premiums, the policy will remain active.
Permanent life insurance has a cash value portion. Your monthly premium payments go to fund three things: the death benefit, administrative costs and cash value, which is set aside in a savings account to grow. Here are more details on a whole life policy:
- Your premiums are fixed.
- The cash value does not earn interest but does increase according to a set schedule.
- You can withdraw from or borrow against the cash value.
Universal Life Insurance
Universal life insurance is a hybrid of life insurance and investing. As in permanent or whole life insurance, coverage lasts as long as the premium is paid, but universal life insurance policies are more flexible than whole life policies. Here are the advantages of using universal life insurance for a 702(j):
- Your premiums can be adjusted.
- The cash value earns interest.
- You can withdraw from or borrow against the cash value.
- You can adjust the death benefit amount.
Shopping around and comparing policies is a good way to spot the best 702(j) retirement policy. Some details to look out for include:
The Insurance Company’s Financial Strength
Look for customer reviews about the insurance company you’re considering. Some good sources for insurance company reviews include the Better Business Bureau, the J.D. Power Life Insurance Study and the National Association of Insurance Commissioners website, where you can search for customer complaints by company.
A 702(j) can be useful for some individuals, said Michael Gerstman, a financial advisor with Gerstman Financial Group. “Unlike the Roth plans, there is a significant death benefit payable if/when the individual dies.” And life insurance contributions are risk-free, as opposed to investing in stocks or mutual funds. “There are also no restrictions like the premature withdrawal penalty of age 59 1/2 or the required minimum distribution age of 70 1/2 of traditional types of retirement plans,” said Gerstman.
But a 702(j) has its drawbacks, especially when compared to traditional retirement plans. Several factors should lead you to think twice before investing your retirement funds in a 702(j).
No Initial Tax Benefits
You only receive tax benefits when borrowing from the policy or as tax deferrals on the cash value’s growth.
A 702(j) is sold by an insurance broker and is likely more expensive than contributing to your retirement accounts.
There is no low-cost brokerage like Fidelity or Vanguard that offers a 702(j) plan, which makes the field subject to unusually high fees from companies — insurance companies, usually — that offer 702(j)s, according to Steven Jon Kaplan, CEO of True Contrarian Investments.
You’ll Lose Money If You Don’t Pay Your Premiums
In the event you stop making payments, you don’t get back all the money you contributed. Remember that your monthly premiums cover fees and commissions, the death benefit and the cash value portion. Stop paying and you’ll lose the death benefit portion and any fees you paid. The available cash savings can be collected but you’ll have to pay taxes on the interest earned.
Anyone trying to decide how much to invest towards retirement and where should consider how a 702(j) compares with other options.
702(j) vs. 401(k)
All 401(k) plans are sponsored by an employer, who might also contribute funds towards your retirement account. The money is usually invested in a mutual fund, which will likely grow higher in value than a 702(j) whose cash value sits in a savings or money market account.
702(j) vs. IRA
In the case of an IRA, you open the account yourself with a brokerage and can decide how to invest your funds, giving you more freedom than with a 702(j). The IRA contributions are deductible in the tax year paid, and you pay taxes on the money when you withdraw it at retirement.
The money you pay into a 702(j) is taxable at first, although borrowing from the policy is tax free.
702(j) vs. Roth IRA
A Roth IRA‘s tax structure is similar to a 702(j) because you contribute post-tax money into each plan. You can then withdraw the money tax-free in retirement. But you have more freedoms with a Roth IRA than a 702(j) because the money can be invested in higher-return funds.
A 702(j) can potentially be a scam if an insurance advisor markets the policy as a retirement account. As you’ve learned, 702(j)s aren’t retirement accounts like IRAs are — they’re basically life insurance policies. Leveraging a 702(j) using the Infinite Banking Concept has its advantages, although it shouldn’t be the primary retirement investment vehicle.
Because a 702(j) is not really retirement savings, focus on contributing and growing true retirement accounts like a 401(k) or a quality IRA first.
Kaplan only recommends 702(j) plans for high-net-worth clients who have already maxed out their traditional retirement plans and “have tons of money left that they will not need in upcoming years for expenses or anything else.”
There are better ways to save for retirement outside of a 702(j) retirement plan:
- Savings Accounts: If you’re close to retirement and prefer not to risk your savings, a certificate of deposit or money-market or high-yield savings account can provide a small amount of growth while protecting your cash.
- Roth IRA: You can contribute post-tax money into a Roth IRA and withdraw the money tax-free in retirement.
- 401(k): This retirement plan set up by your employer is especially attractive if your employer is willing to match the amount you contribute to your account.
- 403(b): Similar to a 401(k), a 403(b) is for public-sector and tax-exempt organization employees.
- Investments: A diversified investment portfolio of real estate, stocks, bonds and annuities is a solid strategy to maximize returns and minimize the risk of loss.
A 702(j) can supplement your retirement planning by providing a way to borrow and withdraw money tax-free while ensuring that your loved ones inherit a death benefit. But 702(j) plans should never replace actual retirement savings like an IRA or 401(k) which, if invested properly, will provide the funds you will need in your later years from the cash saved for retirement — all without a monthly insurance premium payment.
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