Since I am dually licensed in securities (1979) and insurance (1978) I often find myself apologizing to investors for some professionals in both industries. What professionals from both industries have in common is that too often we 1) are in the habit of asking bad questions and 2) leave the impression that it's all about our making a commission on the sale.
David Baker, a specialist at Edison International came to us with a question. He had just been told that he was "overfunding his 401(k)" and that it was a much smarter move for him to exchange his 401(k) for a 7702 private plan. He wanted to know if we offered 7702 plans too. I must tell you that one of my pet peeves with my peers is that we are fond of attempting to make things sound sexy and exclusive to increase appeal. If it sounds oblique and different it has to be good, right?
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What it is; what it isn't
7702 comes from the Internal Revenue Service Code 7702. Which means this section identifies provisions of the IRS code that is related to life insurance products. Isn't that sexy? What makes this ploy even more interesting is that there is no such thing as a 7702 plan. It's not an account and it's not a plan. Something called a 7702 plan is not a "retirement plan" of any type, as most people understand retirement plans. Instead, it is another name for a life insurance policy, often variable universal life. Isn't that exclusive?
Some advisors are using words similar to the 401(k) name to recast life insurance policies as 7702 plans, in their attempt to have investors associate them with the same concept of retirement plans.
To be clear, I have no agenda to hate on life insurance plans. But let's distinguish between the real and the manufactured. Further, let's understand that investments are for living and insurance is for protecting loss. There are vastly different goals that every family is trying to accomplish. The marketing of whole life insurance policies as a form of savings and investment is entirely the creation of the insurance industry.
Boatload of commissions
Wealthfront Knowledge Center makes it clear that, a retirement account like a "401(k) or an IRA is an account that holds assets that you own, but an institution has on deposit for you. There are extensive regulations and definitions around companies and organizations that are allowed to hold the accounts and manage the relationship with you. A life insurance policy, in contrast, is a contract between you and the company. At its base, the policy is an arrangement between you and the life insurance company. The terms are set at the beginning and generally are highly favorable to the insurance company, and you can't change them as your life evolves. While the terms on variable universal life policies are more flexible than whole life, the economics are designed to be extremely profitable for the insurance company."
It is a far better idea to determine what goals you as the investor are working to achieve. Instead of talking about product first, financial advisors worth their licenses work to help investors see how much money they will need in the future to retire with dignity. Or when in retirement, the job includes determining what risks are appropriate to take, both emotional risks and financial risks. It is a beautiful thing when retirees can see to their satisfaction that the amount of money needed is there to keep making work options, no matter which market is going haywire remains consistent, and what withdrawal rates are reasonable so that they can stay in the game for as long as they live.
Live too long, die too soon
When it comes to life insurance planning and you are asked the question, "How much can you afford?" just know that is a bad question. A better question is in the event of loss to a bread winner, married or not, is how much money on a monthly basis is each survivor trying to replace? For example, we are working with a soon-to-be mom, age 39 who will not likely marry the professional football player father. But Nicole Miller wanted to know what would have to happen for her to continue her lifestyle for herself and her child due in July in the unlikely event the same age father would die prematurely. Now that's a much better question to answer. In this case Nicole is receiving $5,000 a month. With the assumption that she set the withdrawal speed limit at 4% a year, Nicole now knows that it is necessary to put $1.5MM worth of life insurance on the father today so that she could have an annual income of $60,000 a year, no matter what. Rather than lead with the product that might pay the professional the most amount of money it is better for the potential survivor to know to her or his satisfaction that if the breadwinner passes away too soon, financially it is a non-event. The type of policy is appropriately a distant second in priorities. While there is time determine how much money does it take to make work optional? In the event of death, how much money does each survivor need today to maintain the same standard of living? It doesn't get any easier. It gets harder when investors throw darts at products instead of first determining their goals and objectives.
Have a question for the Money MD? Leave a comment below or contact us.The opinions expressed in this article are for general information only. They are not intended to provide specific advice or recommendations for any individual and do not constitute an endorsement by NPC. Tax and estate planning services are offered through qualified tax professionals and/or estate planning attorneys.