What Is a 7702 Retirement Plan? | Ask A Fool 1/24/14 | The Motley Fool

TL;DR

A 7702 retirement plan is not a distinct retirement plan, but a marketing name for some form of insurance policy associated with subsection 7702 of the tax code. Robert Brokamp says it lacks the upfront deduction of a traditional 401k and will probably carry higher expenses. His comparison covers taxation, growth, guarantees, insurer ratings and better retirement and insurance choices, so read on before accepting an agent’s proposal.

Transcript

hello everyone I'm Robert brokamp the senior adviser for the mle fools ruly retirement service here we are with another episode of ask a fool this one comes from Michael he says what are your thoughts on a 772 retirement plan we are in negotiations with an agent about a 7702 plan that is alleged to be better than an IRA or 401K in terms of safety a... Read More

Key Insights

• The label can mislead: The term “7702 retirement plan” does not identify a separate retirement-plan type in Brokamp’s explanation. It is a name created by the insurance industry for an insurance product connected in some way to subsection 7702 of the tax code. Buyers therefore need to identify the actual policy being offered before comparing it with a 401k.
• The sales context matters: Michael is already negotiating with an agent who claims the 7702 option is better than an IRA or 401k for both safety and growth potential. Brokamp challenges that framing at its foundation. Rather than treating the label as proof of special retirement advantages, he reframes the proposal as the purchase of an insurance policy with its own costs, access rules and guarantees.
• Upfront deductions differ: A contribution to the traditional 401k used in Brokamp’s comparison produces a tax deduction. Putting money into the product called a 7702 plan does not provide that deduction. This is one of the clearest disadvantages he identifies because it directly separates the proposed insurance arrangement from the tax treatment offered when money enters a traditional 401k.
• Traditional 401k taxation is clearer: Brokamp describes a traditional 401k as growing tax deferred, with distributions taxed as ordinary income when the money comes out. He does not assign one universal withdrawal treatment to every product sold under the 7702 label. Instead, he says the result depends on what the product really is and how its accumulated value is accessed.
• Cash value loans affect access: One possible way to obtain money from the insurance product is through a loan against its cash value. Brokamp raises this possibility to show why the details behind the 7702 marketing term matter. A buyer cannot reliably understand access or tax treatment merely from the label because the mechanism for reaching the money may be part of the underlying policy design.
• The product may differ materially: Brokamp also says the proposal might actually involve a variable annuity. That possibility reinforces his warning that “7702 plan” is not sufficiently precise for comparison. Before judging growth, safety or taxation, the buyer must know whether the agent is offering an insurance policy with cash value, a variable annuity or another specific insurance arrangement.
• Superior growth is doubtful: Brokamp doubts that the proposed insurance product has better growth potential than a 401k. He says the investments inside an insurance policy are likely to be much the same as investments available within a 401k. If the underlying investments are similar, the insurance wrapper does not by itself establish the agent’s claim of superior growth.
• Higher costs have two sources: Brokamp expects more expenses inside the 7702 product or another insurance policy. One reason is that the investments within the policy tend to be more expensive. Another is that the customer is buying insurance and must pay for that feature. These combined costs weaken the case that similar underlying investments will deliver better growth through the insurance product.
• Guarantees must be specific: Insurance may provide a safety advantage, but Brokamp does not treat safety as automatic. He says it depends on the guarantees written into the policy. Those guarantees might concern a base return, a value at death or a value at a specified point, so the buyer needs to determine exactly what is guaranteed rather than relying on the broad sales claim.
• Insurer strength supports guarantees: A contractual guarantee depends on the insurance company behind it. Brokamp recommends reviewing the company’s safety through S&P or Moody and seeking a rating of A or higher. This check is part of evaluating the product’s safety, since promised values are only meaningful in relation to the insurer responsible for providing them.
• Employer matching strengthens the 401k: Brokamp recommends using a workplace 401k and places particular emphasis on taking advantage of an employer match. He says the match should be used no matter what. Combined with the 401k’s tax benefits and the insurance product’s higher anticipated expenses, that match makes the workplace option his preferred retirement-saving route in the situation described.
• Insurance needs should stay separate: Brokamp’s insurance guidance focuses on term life insurance for people who have children. He also says disability insurance and long-term care insurance can be considered. This keeps the insurance decision tied to an insurance need instead of treating an insurance policy marketed under subsection 7702 as the preferred vehicle for accumulating retirement savings.

Questions & Answers

Q: What is a 7702 retirement plan, and how does it differ from a 401k?

A 7702 retirement plan is not a distinct retirement plan, according to Robert Brokamp. It is a marketing name created by the insurance industry for some form of insurance policy associated with subsection 7702 of the tax code. Contributions to the proposed insurance product do not receive the deduction available for contributions to the traditional 401k in his comparison. A traditional 401k grows tax deferred and its withdrawals are taxed as ordinary income, while treatment of the insurance product depends on its structure and how the money is accessed. Brokamp also expects the insurance policy to have higher expenses.

Q: Does a 7702 plan offer better growth than a 401k?

Brokamp doubts that the insurance product will provide better growth. He says the investments found inside an insurance policy are likely to be much the same as those available in a 401k. The insurance policy will probably carry more expenses because its investments tend to cost more and because the buyer is also paying for insurance. Those added expenses undermine the claim that the product’s growth potential is superior. The actual proposal still must be identified because it could involve cash value or possibly a variable annuity.

Q: Is a 7702 insurance policy safer than a 401k?

It may include safety features, but Brokamp says the answer depends on the guarantees within the particular policy. A guarantee might provide a base return, a value at death or a value at a certain point. The buyer should examine those precise promises instead of assuming the 7702 label itself means safety. Brokamp also recommends checking the insurance company through S&P or Moody. He advises looking for an insurer rated A or higher because the company stands behind the guarantees.

Q: How can money in a 7702 product be accessed?

Brokamp says the method depends on what the customer is actually being sold. One possibility is accessing the policy’s cash value through a loan. Another possibility is that the proposed product is really a variable annuity. These structural details affect how access to the money should be evaluated. Because “7702 plan” is only a marketing label in his explanation, it does not provide enough information to determine the access method by itself.

Q: Why are expenses higher in a 7702 product?

Brokamp identifies two reasons that expenses will probably be higher inside the insurance policy. First, the investments held within insurance products tend to be more expensive. Second, the customer is paying for an insurance policy in addition to the investment component. This matters because he expects the available investments to be much like those inside a 401k. Paying more around similar investments makes the claim of stronger growth less persuasive.

Q: Should I choose a 7702 plan or a workplace 401k?

Brokamp recommends the 401k rather than the product marketed as a 7702 retirement plan. His reasoning combines the traditional 401k’s tax benefits with the higher expenses he expects in the insurance policy. If a workplace 401k includes an employer match, he says to take advantage of that match no matter what. He therefore concludes that the insurance proposal is not the best bet. His recommendation is to stay away from the 7702 product described in Michael’s question.

Q: Can a self-employed person use a 401k instead?

Yes, Brokamp says a self-employed person can open a 401k independently. He presents this option after recommending a 401k over the insurance product marketed as a 7702 plan. The reason is that the 401k offers tax benefits that the insurance proposal lacks at contribution, while the insurance policy will probably have higher expenses. A person with a workplace plan should use that plan, particularly when it includes a match. Self-employment therefore does not require turning to the 7702 proposal.

Q: What insurance does Robert Brokamp suggest considering?

Brokamp says to consider term life insurance if you have children. He describes it as about the only insurance that everyone needs in the context of his answer. He also says disability insurance and long-term care insurance can be considered. These are presented as insurance choices, separate from his preferred retirement-saving approach. For retirement saving, he favors the 401k and advises staying away from the product marketed as a 7702 plan.

Summary & Key Takeaways

• Identifying the proposed product: Michael asks whether a 7702 retirement plan offered by an agent is better than an IRA or 401k for safety and growth. Robert Brokamp responds that no distinct 7702 plan exists. Instead, the customer is being sold some form of insurance policy. The name was created by the insurance industry and refers to subsection 7702 of the tax code, so the product should be evaluated as insurance rather than accepted as a special retirement-plan category.

• Comparing contribution tax treatment: Brokamp begins the comparison with a traditional 401k. Money contributed to that 401k provides a tax deduction, while money placed into the product marketed as a 7702 plan does not. A traditional 401k then grows tax deferred, and withdrawals are taxed as ordinary income. The insurance product’s treatment depends more heavily on its actual structure and on how the owner accesses its value, so the marketing label alone does not explain the tax consequences.

• Examining access and growth: Access to the insurance policy’s money might involve a loan against cash value, or the proposed product might actually be a variable annuity. Those details matter when assessing how withdrawals or access would work. Brokamp doubts the claim of superior growth because the investments inside an insurance policy can be much like those found in a 401k. The insurance option will probably have higher expenses because its investments tend to cost more and the buyer is also paying for insurance.

• Evaluating safety and guarantees: Brokamp allows that an insurance policy could offer greater safety, but only if its specific guarantees support that claim. Possible guarantees include a base return, a value payable at death or a value at a particular point. He advises checking the financial safety of the insurance company through S&P or Moody and looking for a rating of A or higher. Safety therefore depends on both the contract’s guarantees and the strength of the insurer responsible for fulfilling them.

• Choosing retirement and insurance options: Given the traditional 401k’s tax benefits and the insurance policy’s higher expenses, Brokamp says the 7702 proposal is not the best bet. He recommends a workplace 401k, especially when an employer match is available, and says self-employed people can open one themselves. For insurance, he points primarily to term life insurance for people with children. Disability and long-term care insurance may also be considered, but he advises staying away from the product marketed as a 7702 retirement plan.