Your Investment Guy Doesn’t Really Care About You……Do It Yourself!

Posted by D. Gregory Steliotes on April 30, 2021

Many of you may be looking for a way to supplement your savings, whether that be for retirement, unanticipated expenses or as a legacy for your family.

You have a number of options available, including IRAs, Roth IRAs, 401(k)s and other tax-advantaged plans. If you’ve maxed-out these strategies and have been looking for alternative savings plans for retirement, you might have come across the term Section 7702 plan in the media or from a friend.

But in truth, the name itself is a misnomer. It’s not really a retirement plan at all, but rather a life insurance product that takes advantage of a provision in the tax law (codified in Section 7702, naturally) to accumulate savings on a tax-advantaged basis.
In the insurance industry, this strategy is variously referred to as a Life Insurance Retirement Plan (LIRP), Insured Retirement Plan (IRP), or in our practice an Insured Accumulation and Distribution Plan. This is not a replacement for traditional retirement savings plans, but a valuable supplement to them for some.

Here’s How it Works

This strategy involves purchasing an insurance policy, though with a twist. Ordinarily when shopping for life insurance, one would look for the highest death benefit at the lowest cost. In this case, you would purchase a policy with the lowest death benefit—just enough to trigger the statutory tax protection afforded to life insurance contracts under tax law.

The policy is purchased with after-tax dollars, so there is no deduction for the initial purchase. However, life insurance enjoys several income-tax advantages in the Internal Revenue Code:

  • Cash value grows with no current income tax

  • Cash can be accessed without income tax

  • Death benefits are income tax-free

The tax treatment is similar to a Roth IRA. And unlike a traditional qualified plan account, there are no early withdrawal penalties or mandatory distributions. Life insurance can also offer asset protection from creditors.

The underlying insurance policy can be structured using various crediting methodologies. including letting the insurance company invest for you, selecting an index to track (e.g., the Standard & Poor’s 500), or selecting from a choice of many individual investment accounts, like you would see in a 401(k) plan.  

A Couple of Things to Remember

Let me stipulate upfront that this is NOT a replacement for standard qualified retirement plans such as Individual Retirement Accounts, 401(K) plans or Roth IRAs. Instead, they should be used as supplements to those plans, after you have maxed-out your contributions.

The beauty of this plan is that unlike those qualified plans, it has no caps on how much you can contribute. That’s why some employers use this vehicle to reward and retain certain high-value employees, in addition to their own company retirement plans, or as a sinking fund for deferred compensation plans.

One other important thing to remember is the time horizon of this instrument. It can take years for the insurance policy to gain an advantage. That means you wouldn’t want to use this as a short-term strategy, or to catch up on retirement savings that you might need early in your retirement.

The upshot of all this? This instrument is not for everyone, and it should be used only as a supplement to more traditional forms of qualified retirement plans. But if the fact patterns of your life situation fit this vehicle, it’s a wonderful way of accumulating and distributing savings for your golden years.

Want to learn more about these alternative retirement savings vehicles? As always, we’re ready to help guide you through any insurance and risk-mitigation issues you might encounter, and help you craft the best coverage options for your organization. Just give us a call today, at (216) 350 5050.

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About the author D. Gregory Steliotes

Greg Steliotes is a principal with the Pittsburgh-based firm Innovative Benefits Consulting, Inc., which engages in a joint venture with Armada Risk Partners on life insurance issues.