There has been a significant buzz recently regarding a supposedly revolutionary new account referred to as “770” or “7702” accounts. Everywhere from message boards, to blogs, to personalized Facebook feeds, the supposed benefits of these accounts have been touted as revolutionary. The purported benefits are as follows:
- Is a secret account type used by wealthy people
- Returns 40-50% better than CD’s and other safe investments
- Can withdraw anytime without penalty
- Is not reportable to the IRS
- Lets you retire 100% tax-free
Well, that certainly sounds amazing, doesn’t it? But, as always, if it sounds too good to be true it probably is. So what is this plan, really? A “770 account” is a marketing term employed to sell whole life insurance. Rather than maximizing the death benefit of the insurance, however, the contract is supposedly designed to maximize the living benefit, or use of the cash value. The consumer is using a life insurance contract as a savings account. Once the policy has been sufficiently funded, then withdrawals may be made tax-free. This is nothing new or revolutionary, or even all that useful for most people. The “withdrawals” are really only the consumer borrowing from their policies (not actually taking a disbursement). Of course, these loans must be paid back or the policy lapses. By IRS regulations, loan proceeds are never considered taxable income whether they are from an insurance policy, credit cash advance, or a basic bank loan. What is often left out of the sales pitch is that interest on these policies IS taxable (making this type of account clearly not tax-free). This strategy is often referred to as infinite banking (borrow from yourself, pay yourself back, leave the bank out of it). It is important to realize however, that if interest payments are less than the loan interest rate, then you are not making much money, at least not on that portion borrowed. Further, if the policy lapses you owe taxes on any gains. So what about the higher returns, 40-50% greater than savings accounts and CD’s? Savings/Money Market/CD returns are lower because they are mostly short-term in nature (you can access your savings at any time). A life insurance policy pays higher rates of return over the long run because there are often significant lock-up and penalty periods. So while salesperson may tout liquidity relative to traditional retirement accounts, the reality is anything but. With an insurance policy, the money you can take out will not match the money you put in for roughly 12-15 years after the contract is in force. A large lump sum must be paid up front or consistent payments be made over time to build the cash value. If payments are missed and not reconciled, then the policy will lapse. One strategy to increase the living benefit of the cash value is to overfund the policy, but there is a potentially sever penalty associated with this, in that the contract may become a modified endowment contract (MEC). The exact working of a MEC are a topic for another day, but, simply put, if the contract becomes a MEC then all withdrawals are taxed and incur penalties, nullifying any benefits of the strategy. Based on the above discussion, the “770 account” doesn’t look all that promising. So why all the hoopla and hype regarding these accounts? The name “770” itself is merely a marketing ploy allowing an existing set of insurance products to borrow the credibility of well-known retirement plans named for their IRS code designations (i.e. 401(k), 403(b), etc…). “770” is not an account, and it’s not a retirement plan. This reference is drawn from IRS code 7702, which simply governs “life insurance contracts”. Linking life insurance contracts subversively to more common retirement plans makes them easier to sell, and insurance salespeople love selling whole life insurance. Products such as these produce enormous commissions for insurance agents. When offered large commissions (often 8-10% over the life of the contract), insurance agents will inevitable develop ever-more creative sales tactics to push the product. The key take away? If you see an advertisement or are approached by someone selling “770/7702 Plans”, remember two things: 1) They are talking about the same old whole life insurance, and 2) They are using a new, aggressive, and severely deceptive sales technique.