What is a 702(j) Retirement Plan?

A Retirement Account to Avoid

If you find yourself getting lost in all the abbreviations and acronyms that identify retirement accounts, let’s look at one you should probably stay away from––the 702(j) plan.

What is a 702(j) Plan?

By now, you’ve likely heard of the 401(k) and the IRA. If you work in certain industries, you might also know the 403(b). These are all legitimate tax-advantaged retirement savings vehicles that have proven track records of building retirement wealth by minimizing the person’s taxes as the account grows.

But just because a financial product has some letters and numbers in its name, doesn’t mean that it deserves consideration. That’s certainly the case with the 702(j).

The 702(j) account, also called a 702 or 7702 account, does have its roots in the tax code but section 7702 refers to insurance policies—not retirement plans. Insurance companies who market these plans knew that if they named this product by some sort of shady code similar to legit retirement accounts, it would gain more credibility. That should be your big red flag #1.

Red Flag #2

If they have to give it a shady name, what are they trying to hide? Go to section 7702 of the United States Code and it instantly becomes clear—it’s not a tax-advantaged retirement vehicle at all. It’s an insurance policy. Do a quick Control-F while on that page and search for the word, retirement. You won’t find it in section 7702.

The Downfalls

The 702(j) is simply indexed universal life insurance, also a product that many financial gurus advise avoiding like the plague. Salespeople will tell you that universal life tell you that it’s the perfect marriage between an investment or savings vehicle and an insurance policy. Be nice to your money—steer clear of products that try and be something they’re not. Problems with these policies include:

  • The money the salesperson says you will make isn’t anywhere close to reality.
  • When the stock market rises, the policy only captures a fraction of the gains and is often capped at a certain amount.
  • Although they say you won’t lose money on the policy, there are some major caveats. hidden in the fine print.
  • The fees associated with these accounts are enormous.
  • The commissions salespeople earn for each sale are very large, making them highly motivated to anybody who will buy.

Insurance Isn’t an Investment

If you’re looking to invest your money for retirement, do it through investment products. Using a traditional 401(k), IRA, or a non-tax-advantaged brokerage account is the better way to invest, according to most experts. Using an insurance product as an investment vehicle forces you to pay high fees, don’t give you many (if any) investment choices, don’t accurately capture the positive moves in the stock market, and are very difficult to understand.

If you want to purchase life insurance, do it through level term life insurance. Because life insurance is insurance that protects the family if a primary wage earner passes away, you probably don’t need it your entire life. Once you have a sizable savings where you and your family aren’t counting on a person’s income to support the family, you no longer need life insurance. That’s usually 20-30 years.

Level term insurance is cheap to buy and maintain—so cheap that many agents won’t sell it because there’s little commission in the product. Level term life insurance plus a well-thought-out investment portfolio will build wealth more efficiently than something like a 702(j).

A Few Caveats

Experts say that universal life insurance might be a good idea for a very small subset of people for tax efficiency but those are often higher net worth people who comprise a single-digit percentage of the population and need a place to put excess money to avoid certain taxes. That’s not true of most people.

Finally, the good news is that you’ll have a tough time finding a place to purchase a plan marketed as a 702(j) plan but just in case you run across somebody trying to sell it, the answer you should give is, “thank you but no.”

Remember, if you need to protect yourself again potential loss, you want insurance. If you want to build your retirement savings, use a 401(k), IRA, or 403(b). If you’re a high net worth individual, you should have a financial adviser that specializes in high net worth clients. Hint, they WON’T recommend a 702(j).