7702 plan: Cash-value life insurance policies are tax-deferred because of the Internal Revenue Code’s section 7702, which explains how cash value policies maintain their tax-deferral status. No, a 7702 plan isn’t a term or whole life insurance policy, as the name might imply.

It’s vital to comprehend the coverage you choose and how your premiums will be handled before signing a life Insurance contract. Any potential tax benefits from the policy’s cash accumulation are included here. You can better comprehend the tax-advantage status of a policy and its impact on your cash-value account by knowing about the Section 7702 code.

7702 Plan

A 7702 plan is a tax-deferred life insurance policy that generates cash value over time in addition to the death benefit. A cash value life insurance policy is another name for this life insurance.

What is the 7702 Plan

The conditions that cash value life insurance plans must follow to maintain their tax-advantaged status are defined in Section 7702 of the Internal Revenue Code. This section 7702 code sets the premium payment criteria and the corridor and cash value accumulation tests that must be met for the cash value of permanent insurance to grow tax-deferred.

Any cash value life insurance policy issued after 1985 is subject to Section 7702 rules, which are based on the following guidelines:

• To qualify for tax benefits, you must pass two “tests”: the cash value accumulation test (CVAT) (also known as the guideline premium) and the corridor test (GPT).
• The funds from the policy are recognized as income if a contract does not match the standards.

In no way does the word “7702 plans” refer to qualifying plans, and any cash value life insurance policy you purchase is subject to the same tax laws.

What is a Cash Value Life Insurance Policy 

The element of your life insurance policy that earns interest and may be available for withdrawal under certain circumstances is the cash value component.

The following life insurance policies can be classified as cash value life insurance:

• Universal life insurance
• Whole life insurance
• Variable universal life insurance
• Index universal life insurance

They differ from term life insurance in this regard. Term life insurance only covers you for a set period, such as 10, 20, or 30 years. As a result, these plans do not accumulate cash value, and you cannot borrow money or cash them out for anything other than the death benefit.

Can life insurance coverage be used for retirement and investing purposes? Yes, in some situations — for example, if you borrow against your cash worth or withdraw it after retirement. They’re referred to as “7702 plans” by confident deceitful marketers.

However, the primary goal of life insurance policies is to provide financial security to your loved ones through the death benefit, and they should not be viewed as a substitute for eligible retirement plans.

Section 7702 Requirements Plan

Contracts for life insurance must satisfy either the cash value accumulation test (CVAT) or the guideline premium and corridor test (GPT).

Cash Value Accumulation Test (CVAT)

According to the cash value accumulation test, the contract’s cash surrender value “may not at any time exceed the single net premium which would have to be paid at such time to finance future benefits under the contract,” according to the cash value accumulation test.

That implies the amount a policyholder can get out of the policy if they cancel it (commonly referred to as the “savings” component of cash value life insurance) can’t be more than the amount the policyholder would have paid in a single lump sum, excluding any fees.

Guideline Premium and Corridor Test (GPT)

Amount paid under contract does not ever go over maximum recommended amount, as of the time in question, says the guideline premium and corridor test. This means the policyholder could not have paid more into the policy than was required to cover the insurance benefit.

If any of these conditions are not met, the contract revenue is considered as ordinary income for the year and taxed in accordance with section 7702 if the policy does not pass (g). In other words, the contract’s owner will no longer benefit from the tax advantages of a valid life insurance policy.

Importance of Section 7702

Section 7702 is significant because it determines which types of cash value life insurance plans are eligible for tax benefits. Suppose a life insurance policy does not meet the requirements of this section of the Internal Revenue Code.

In that case, the beneficiary will be taxed on the growth of the cash value inside the procedure and the death benefit. Because the vast majority of life insurance plans already meet the requirements of this code, policyholders rarely have to worry about this.

The Internal Revenue Code’s Section 7702 was enacted in reaction to the significant number of cash-value life insurance policyholders exploiting it as a tax shelter. Many plans issued before 1985 had a considerable cash value component with much room for growth, which the IRS tried to limit with Section 7702 provisions.

Since 1985, there have been defined restrictions on life insurance cash values that must be adhered to keep their tax-favored status.

How 7702 Plans Work

As previously stated, Section 7702 “plans” are not individual life insurance policies. They are stand-alone life insurance policies with a cash value. Some insurance agents may have referred to them as “7702 plans” to guarantee that consumers enrolled in a sort of qualified plan with tax benefits.

7702 plans, on the other hand, are not the same as retirement plans like 401(k)s or individual retirement accounts (IRA). A key distinction is that 401(k) plans accept pretax contributions (unless it’s a Roth plan), whereas 7702 programmes only accept after-tax contributions.

Unlike a qualified retirement account, you cannot deduct the cost of a 7702 plan’s premiums since the IRS considers them a personal expense rather than a retirement plan contribution.

These plans’ cash value increases tax-deferred, and policyholders can borrow money from them tax-free. It is true of any cash value policy, regardless of whether it is referred to as a 7702 plan.

Whole life insurance, universal life policy, variable universal life policy, or indexed universal life policy are examples of 7702 plans. The cash value that builds up inside a policy is determined by the type of insurance and the money paid into it over time.

Variable policies can lead to more robust long-term growth but also lose value if markets fall. Indexed universal life insurance is generally safer since the policyholder’s cash value is guaranteed not to fail if the index it is linked to performs poorly.

In comparison to flexible policies, they have reduced long-term growth potential. Section 7702-qualifying policies are always tax-free death benefits, regardless of the type of insurance used.

Why do permanent life insurance contract get tax exemption?

Life insurance contracts are designed to pay a monetary benefit to their beneficiaries when a person dies. Permanent life insurance policies, such as whole or universal life, can accumulate a cash value that can be withdrawn or borrowed against while the insured is still alive.

However, because these contracts are considered insurance rather than investments, they are eligible for certain tax benefits. A policy loan, for example, is tax-free when received.

Modified Endowment Contract (MEC)

When a life insurance policy has been “overfunded” with too much cash value compared to its death benefit, a “modified endowment contract” (MEC) has been created, as defined by IRC Section 7702a. TAMRA (Technical and Miscellaneous Revenue Act of 1988) lays a seven-pay test.

which states that premiums put into the policy cannot exceed the full amount required to pay up the coverage within seven years. 

When an insurance policy becomes a MEC, it loses its tax benefits and cannot convert to non-MEC status.

What is the Difference Between a 7702 Plan and a Retirement Plan?

A cash-value life insurance policy, also known as a 7702 plan, has a cash value in addition to the death benefit. When you put premiums into these projects, some money goes toward the death benefit, and some go toward the cash value.

One of the main reasons someone might want to think twice about investing in a cash-value life insurance policy is that these policies might have high management costs, mortality and expense charges, and administrative fees, including agent commissions.

Individual retirement accounts, such as 401(k) from your company, on the other hand, usually do not demand commission fees to enrol in the program. However, this does not negate that a 401(k) or other qualifying retirement plans, such as a Roth account, have costs. You should always read the terms of any retirement plan you are considering to ensure you are aware of the plan’s total cost.

The 7702 program’s performance in comparison to other retirement plans is determined by the investments made using the monies you contribute. Whatever method you choose, it’s a good idea to understand the investments in which your money is invested.

Plan 7702 Changes

For the first time since its inception 32 years ago in 1988, Congress amended section 7702 in December 2020.

The minimal interest rates to be employed in the design of cash value life insurance products were adjusted by the Consolidated Appropriations Act to allow for ongoing low-interest rates in the rest of the economy.

Existing policyholders do not need to be concerned about their guaranteed policy values because these modifications have no impact on existing policy guarantees until significant changes are made.

Life insurance providers have adjusted their new products to comply with this legislation as of January 2022. Many corporations have tried to maintain high guaranteed cash values, even if dividends are expected to be lower across the board. To have a similar monetary value, premiums are significantly higher.

None of these developments diminishes the importance of whole life insurance as a valuable financial tool and liquid form of savings in addition to the guaranteed death payment.

The Final Thoughts

A 7702 plan isn’t a retirement savings account. It is a provision of the Internal Revenue Code that governs how life insurance is taxed. Life insurance, according to some, is the most significant tax break available.

Life insurance is a terrific way to enhance your wealth while you’re alive and provide financial protection for your loved ones after you die. It can offer you retirement income in your golden years, as well as let you leave money to your spouse, children, and grandchildren tax-free!

Profiteers, on the other hand, may try to sell you a high-cost policy that isn’t suited for you. Finally, it’s up to you to educate yourself about these plans and carefully weigh their benefits and drawbacks before purchasing coverage you don’t require.