770 Accounts 101: Life Insurance Hope or Hype?

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You may have seen ads talking about "secret 770 accounts," financial vehicles that let you retire 100 percent tax free, aren't reportable to the IRS and never go down in value. Many of these ads have a tone that says "scam" to the more cautious investor. While it isn't fair to call them a scam, it is also not fair to call them retirement programs -- and, arguably, they shouldn't be called accounts either. They are simply a form of permanent, whole-life insurance.

The name 770 account is derived from Section 7702 of the tax code (sometimes they are referred to as 7702 accounts), presumably to equate them to 401(k) retirement accounts that also get their name from the tax code. Section 7702 concerns the rules regarding taxes and life insurance policies, which can become fuzzy with whole-life policies that contain death benefits as well as investment components.

With whole-life policies, death benefits are tax-free and the interest and gains in the account aren't included in the policyholder's current income. However, the death benefit could be lowered to impractical levels, making the cash-value so high that the life insurance policy is clearly an investment instead of the life insurance policy it was intended to be. Thus, you could have a more stable life insurance policy with the tax benefits of more risky investments.

Section 7702 draws the line to which something can be called either life insurance or an investment. 770 accounts are life insurance contracts that, if properly designed, take you right up to that line without crossing it. There is nothing wrong with that -- that is why the line exists.

Newsletters touting 770 accounts point out that big banks have millions of dollars tied up in these investments, and the extremely wealthy can use them as tax shelters. Are you extremely wealthy (or a big bank with thousands of employees)? If not, that is really an irrelevant selling point.

The more money that you can devote to this form of investment, the more likely it is to make sense to you because of the tax sheltering aspects compared to other options at that income level. Limits on IRA contributions and other investments make 770 accounts far more attractive. However, you don't care how it affects big banks; you only care about whether it makes sense for you.

As stated above, a 770 account gets as close to the line of a defined investment as possible without crossing it. Essentially, your life insurance policy is "overfunded" to the fullest extent possible. Over time, the growth allows the policy to be borrowed against to fund retirement costs. Keep in mind that that overfunding involves higher premiums -- to pay for the benefits, whole-life policies have far higher premiums than term life policies.

Meanwhile, you do receive dividend payments (assuming you have purchased your policy from a mutual insurance company and your policy is structured to pay dividends). These constitute the yearly payments that 770 pitchmen refer to. Again, there is nothing special here; that is how life insurance works. Your premiums are designed by the insurance company to take those payments into account.

Lost in the Marketing

Also consider that it takes time for whole-life policies to build up sufficient cash value to meet your objectives -- the older you are, the less this form of investment makes sense. Unfortunately, as it is being pitched as a safe retirement program, this aspect can get lost in the marketing.

Since 770 accounts are individual contracts with an insurance company, the burden is on you to find the collective fees and costs associated with the policy, as well as the interest rates that are charged when borrowing against the policy (guaranteed or variable) and what happens if repayments are late or missed.

Whole-life contracts are often quite profitable for insurance companies -- that is why they sell them -- but you have to balance those costs against other uses of your money, such as investing in an IRA separately and buying term-life insurance to cover your insurance needs.

To educate yourself on the topic, start by acquiring a thorough understanding of whole-life insurance policies (in this case, it is usually variable universal whole-life policies) from respected sources. Then if you are still interested, look at individual vendors of 770 plans to see the similarities and differences from a standard plan.

Our advice isn't to sign anything until you can do a complete cost-benefit analysis, compared to an alternate use of your money (don't forget any life insurance needs you may have). Also, make sure that you understand the fine print of the contract regarding the possibility of interest rate changes or what happens when the money is withdrawn. If you can't do that analysis on your own, seek the advice of an independent financial planner.
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