Whether you've had an insurance salesman aggressively pitch you a 702(j) "retirement plan" or you've read information about it online, you may still be wondering what it is. A 702(j) plan is not a retirement plan, even though that's how it's marketed. It is actually a life insurance policy.
The name 702(j) plan comes from Section 7702 of the Internal Revenue Code, which regulates life insurance. The companies that market 702(j) plans want you to think of a 702(j) account the same way you think about other retirement plans, such 401(k) plans, 457s, individual retirement accounts, 403(b) plans and thrift savings plans. But it's important to understand the distinction: 702(j) plans are permanent life insurance policies, while the others are actual retirement accounts. If you visit the Internal Revenue Service website, you can view all the retirement plan options and learn more about what's included in every plan.
A permanent life insurance policy combines a death benefit with a savings portion. As you pay your premiums, over time you begin to accumulate a cash-value component you can borrow against. The growth of the cash value is tax-deferred, meaning you do not pay taxes on that amount. You are also able to take money out of your cash value as a tax-free loan.
However, it's important to be careful with how much you take out, because if you do not pay back the loan before you die, the death benefit is reduced by the amount of the outstanding loan plus interest. And if you take a loan that is equal to the cash value of the policy, the insurance company will force the policy to lapse and you will be hit with a large tax bill.
Chances are, a 702(j) account will be either a variable or indexed universal life policy. The insurance company will hand you a stack of pages full of legal, hard-to-understand language that includes a policy illustration highlighting optimistic return assumptions. The product is also advertised as having no risk, because it will not decrease in value even if the stock market loses money. You might be wondering if this is too good to be true. In my opinion, the answer is yes. When the index that the policy tracks is performing well, the insurance company caps the amount credited to your account. When the index the policy tracks is down, you may not have any money credited to your account.
The fees on these products are typically outrageously high and are skewed to the benefit of the insurance company and salesman. There are administrative fees, mortality charges, surrender charges and a large upfront commission paid to the agent. It is very difficult to determine the total amount you're paying in fees because of the way they are presented. In other words, the fees are not disclosed.
Fees are extremely important to take into consideration when evaluating options for retirement, because the effects are compounded over a long time horizon, and high fees and costs can cause serious harm to your retirement savings.
Most fiduciaries — individuals who are required to act in your best interest — believe you should fully fund other retirement vehicles first, such as a 401(k), 403(b), IRA or Roth IRA. There is generally more flexibility in your investment options, lower fees and more transparency with these accounts.
Investment advice should come from a fiduciary. If the person you are speaking with does not have to act in your best interest, they may not give you straightforward advice. Before you consider any investment, make sure the person's motives are aligned with yours. Understand what you are investing in, the fees involved and your alternatives, because if something sounds too good to be true, it generally is.
(Editor's Note: This article originally appeared on Investopedia.com.)
— By Sam Dechtman, wealth advisor and partner at Dechtman Wealth Management