You may have seen ads — particularly on the Internet — touting a retirement account called a 702(j) or 7702 that promises a guaranteed tax-free return of up to 60 times that of a standard bank account.
The ads describe the 702(j) as a way “to retire with an extra $4,098 per month” and claim that it is used by “Washington insiders” and well-known billionaires.
Should you open a 702(j)? Should it replace your 401(k) or IRAs?
Well, a 702(j) or 7702 isn’t a retirement account at all. It’s a life insurance policy. The name, like the 401(k), is lifted from Section 7702 of the Internal Revenue Code, which regulates life insurance contracts.
Clever move by the promoters: By linking a section of the tax code to a permanent life insurance policy, they manage to associate their product with retirement plans.
In fact, these policies are designed to provide insurance coverage for your entire life. An inherent feature of these policies, therefore, is cash value: Over time, the cash value increases, and tax law lets you borrow against it tax-free.
The trick is this: In a “702 policy” pitch, you pay extra premiums (more than the policy requires) in order to deliberately increase the cash value — from which you later borrow. This lets the promoters tout the policies as providing “tax-free retirement income.” (The loans are tax-free because they really are a return of your own money, and any excess you get — say, from interest earned — reduces any death benefit your survivors get when you die. In other words, you’re taking money from your spouse and kids, not the insurance company.)
Not only is the above problematic, but the 702 strategy also carries serious risks. If you don’t repay the loan, any investment gains borrowed could become taxable. Interest may be charged on loan balances, and much of the premiums you pay can be eaten up by commissions and fees.
And investing in a permanent life insurance policy to save for retirement could mean diverting assets from your 401(k), where you might get an employer’s match — truly free money. You also could lose out on the tax deductions you get by contributing to your 401(k) or IRA.
High-net-worth individuals are often the target of 702 sales pitches because they’ve maxed out their 401(k)s and IRAs. But they can move on to taxable investment accounts.
Don’t use life insurance as an investment vehicle. Use it for its one intended purpose — to protect someone who would be financially harmed in the event of your death.
Whether you need life insurance, and whether it should be a term policy or permanent insurance, is something you should discuss with an objective, fee-based financial advisor.
There are no get-rich-quick ways to finance your retirement. You must do it through careful planning and consistent saving in workplace retirement plans and IRAs.