There are a lot of options to choose from when it comes to planning for retirement, including 401(k) plans, individual retirement accounts (IRAs) and annuities. While saving in any way is great, each of these offer different benefits and drawbacks. One type of plan, though, should be approached with special caution: The 702(j) “retirement” plan.
While it might sound like yet another retirement plan named after a section of the tax code, a 702(j) plan isn’t really a retirement plan at all. Rather, it is a type of life insurance frequently sold to consumers as a retirement plan. If you’re serious about saving for retirement, this guide explains whether a 702(j) plan makes sense for you and your finances.
702(j) Retirement Plan, Defined
You may see these plans pitched with a few different names, notably “President Reagan’s Secret 702(j) Retirement Plan” or the “Bank on Yourself” method. But a 702(j) plan is not a retirement savings plan like a 401(k) plan. It’s not an investment vehicle. It’s a life insurance contract governed by Section 7702 of the U.S. Code, which lays out the rules for life insurance contracts. The term 702(j) is simply marketing speak, possibly designed to make the 702(j) plan seem more like a retirement plan in the vein of a 401(k) or a 403(b).
Specifically, a 702(j) is a permanent life insurance policy. This means that as long as you pay your premium, you’ll continue to be eligible for the life insurance benefit. This is in contrast to term life insurance policies, which are only eligible for a certain period of time.
Here’s how a 702(j) plan works: you pay a premium each month for the life insurance. You pay extra premiums each month which increases the cash value of your policy, and later you can get that money back or put it toward your premiums (if the cash value of your policy is high enough). If you take that money as a loan, you don’t pay taxes on it. However, since it is technically a loan, you do have to pay it back with interest.
702(j) Plans vs. 401(k)s and IRAs
Unlike 702(j) plans, 401(k) plans and IRA plans are actually designed to save for retirement. In both of these plans, you put money in each month and the money is invested in whatever investment products you choose (often mutual funds). A 401(k) is sponsored by an employer while you open an IRA yourself with a brokerage. In a 401(k), you might get some of your contributions matched by your company.
There are two types of 401(k) and IRA plans – traditional and Roth. In a traditional plan, money is put in before taxes and you pay taxes on the money when it’s withdrawn in retirement. You put post-tax money into a Roth plan. You’re then able to withdraw the money tax-free in retirement. A Roth plan is a good option for people who expect to be in higher tax brackets in retirement than they’re in currently.
By contrast, a 702(j) plan is a life insurance product that some are trying to sell as a retirement plan, but it isn’t one. Technically, a 702(j) plan allows you to withdraw money tax-free, which is a benefit — but, again, you’ll be paying interest on the money because it is technically a loan.
Who Should Get a 702(j) Program?
If your goal is to save for retirement, a 702(j) plan is probably not for you. There are legitimate reasons to buy life insurance – namely to provide money for your family when you die, especially if you are the primary earner in your household. If that’s the case, talk to a financial advisor or an insurance company about purchasing life insurance. But don’t fall for any sales pitches imploring you to pay more than the monthly premium as a way to provide money for you and your family in retirement.
A permanent life insurance policy offers some tax benefits that aren’t available with term life insurance – namely, that the cash value does grow tax-deferred. Generally, though, if you are buying permanent life insurance for its intended use, it won’t be marketed as a 702(j) program.
Are 702(j) Programs a Scam?
Technically, 702(j) plans are not scams. The plans are legal, and if used correctly they aren’t cheating anyone out of money.
The plans are not retirement savings plans, though, and some insurance sales representatives are selling them to consumers as a legitimate retirement plan. Insurance sellers focus on selling 702(j) plans to high-net-worth investors. This is because these people are more likely to have maxed out their investments to their other retirement plans like 401(k) plans and IRAs. They might be looking for a way to boost their savings and find a way to put aside more money for retirement. A 702(j) plan, though, is probably not the best way to go about adding to your retirement savings.
If you’re looking for a retirement plan, a 702(j) plan isn’t for you. It’s a life insurance product that some salespeople try to sell as a retirement plan, but there are better options, like a 401(k) or an IRA. If you’ve maxed out your contributions to those, talk to a financial advisor about other options for tax-advantaged retirement savings.
Retirement Investing Tips
- When you’re planning for retirement, don’t forget about Social Security. To estimate how big of a check you can expect to receive from the government each month, use this free Social Security calculator. To take a larger look at your retirement readiness, use our retirement calculator.
- Between retirement accounts, life insurance policies and Social Security income, it can be hard to account for the various sources of retirement income. A financial advisor can be a big help in putting together a retirement income plan. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
- Know the lingo: Taking control of your personal finances can be overwhelming, in part because there are a lot of terms that you may be unfamiliar with. Here’s a quick guide to some of the common retirement terms you might come across in your research. Take a few moments to familiarize yourself with them so you can feel more confident when you’re talking about finances and planning for your financial future.
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