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Understanding Section 7702 Plans | Bankrate

A 7702 plan is a tax-advantaged life insurance policy and its name is based on the internal revenue code that explains how cash value life insurance policies retain their tax-advantaged status. Contrary to its name, a 7702 plan is not a type of life insurance policy, such as term or whole life.

When you sign a life insurance contract, it’s critical to understand the type of policy you’re selecting and how your premiums will be handled. this includes any potential tax advantage from accumulating cash in the policy. By learning about the section 7702 code, you can better understand a policy’s tax-advantaged status and the impact on your cash value account.

Reading: What is 7702 life insurance

what is section 7702?

Section 7702 of the Internal Revenue Code defines the criteria that cash value life insurance policies must meet to retain their tax-advantaged status. this section 7702 code outlines the guidelines for premiums paid and defines the broker and cash value accumulation tests that must be met in order for the cash value of a permanent policy to grow tax-deferred.

The rules of section 7702 apply to any cash value life insurance policy issued after 1985, based on the following guidelines:

  • There are two “tests” to qualify for tax advantages: a cash value accumulation (cvat) test (or referral premium) and a broker (gpt) test.
  • if a contract does not meet the guidelines, policy proceeds are treated as revenue.

The term “7702 plans” does not refer to qualified plans in any sense, and any cash value life insurance policy you purchase is subject to the same tax rules.

what is a cash value accumulation test (cvat)?

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cvat is one of the tests described and defined in section 7702. the code states that the cash value test is met “if the sum of the premiums paid under the contract does not at any time exceed the limit of the reference premium from that moment on”. time.” This means that the money the policyholder receives from their policy if they decide to cancel cannot be more than what they would have paid for the policy in a lump sum, not including fees. the policy if there is a cancellation is called the cash surrender value.

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An example of a policy that would qualify for the CVAT test is term life insurance. Unlike comprehensive, universal and variable policies, term life insurance does not build cash value. If you own a term life policy, you will not receive any payment if you surrender your policy. This is one of the reasons term life insurance premiums tend to be less expensive, since most term policies don’t have a cash value component.

why is section 7702 important?

Section 7702 is an important code because it dictates which types of cash value life insurance policies are eligible for tax-advantaged treatment. If a life insurance policy does not meet the criteria listed in this section of the Internal Revenue Code, both the growth in cash value within the policy and the death benefit will be counted as taxable income to the beneficiary. most current life insurance policies meet the criteria of this code, so it is rarely an issue for policyholders.

Section 7702 of the Internal Revenue Code was created in response to the large number of life insurance policy holders using cash value life insurance as a tax shelter. Many policies issued before 1985 offered enormous growth potential in their cash value component, which the IRS tried to prevent by implementing the Section 7702 rules. life have had established limits that must be followed to conserve their tax statement.

how section 7702 plans work

As mentioned above, section 7702 “plans” are not an individual type of life insurance policy. they are stand-alone cash value life insurance policies. some insurance agents may have called them “7702 plans” to reassure clients that they were enrolling in a type of qualified plan where contributions are tax-advantaged.

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However, 7702 plans are not like retirement plans, such as 401(k)s or individual retirement accounts (IRAs). One important difference is that 401(k) plans allow pre-tax contributions (unless it’s a Roth plan), while 7702 plans are funded with after-tax money. Unlike a qualified retirement account, if you contribute to a 7702 plan, you can’t deduct the cost of the premiums you pay because the IRS considers them an out-of-pocket expense and not a contribution to the retirement plan. The cash value of these policies grows tax-deferred and policyholders can take out tax-free policy loans from them. but this is the case for any cash value policy, regardless of whether it is called a 7702 plan or not.

A 7702 plan can be a whole life policy, a universal life policy, a variable universal life policy, or an index universal life policy. The amount of cash value that accumulates within the policy depends on the type of policy it is and the amount paid out over time. Variable policies have the potential for higher long-term growth, but can also lose value when markets fall. Indexed universal life policies tend to be safer because the policyholder’s cash value is guaranteed not to decline if its associated index performs poorly. however, they have less long-term growth potential compared to variable policies. Regardless of the type of policy used, policies that qualify for section 7702 always have tax-free death benefits

How is a 7702 plan different from a retirement plan?

A 7702 plan refers to a cash value life insurance policy, which is a life insurance policy that has a cash value beyond the death benefit. When you pay premiums on these types of policies, part of the premium goes to the death benefit and part of the premium goes to the cash value of the policy.

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One of the main reasons someone may want to reconsider purchasing a cash value life insurance policy for investment purposes is that these policies can have expensive administration fees, expense and mortality charges and administrative expenses that may contain agent commissions.

On the other hand, qualified retirement plans, such as a 401(k) received through your employer, generally do not require commission fees to enroll in the plan. However, this does not mean that there are no fees associated with a 401(k) or other qualified retirement plans, such as a Roth account. You should always pay close attention to the terms of any retirement plan you’re considering to make sure you understand the full cost of the plan.

how a 7702 plan performs compared to other retirement plans depends on the investments made with the funds you contribute to the plan. Whichever plan you choose, it’s a good idea to have a thorough understanding of the investments your money is tied up in.

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frequently asked questions

    • what should I do if someone tries to sell me a 7702 plan?
      • How do I know if a particular cash value life insurance policy I’m looking at meets the rules set forth in section 7702?
        • what is the difference between the referral premium test (gpt) and the cash value accumulation test (cvat)?

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