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What is Index Universal Life. Why is it being sold as a 7702 plan, Can I withdraw any amount of money without a tax penalty?

Jul 09, 2013 by ursula from Piscataway Township, NJ in  |  Flag
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The appeal of index universal life products is partly due to the fact that they can be illustrated at interest rates that are higher than those currently being credited to fixed interest universal life policies. There is no standardization for the methodologies used to illustrate current cash values, so an IUL illustration often shows favorable numbers.

Floors and caps, choices of indexes, being unsure of the interest rate a product will receive until the end of a certain period, and non-guaranteed elements that can change make index UL products very complex.

A few things to consider when evaluating an IUL illustration: •What interest rate is the illustration using? •Is it conservative or optimistic? •Is it a level interest rate or have they varied it from year to year? •What would the product look like at a lower interest rate? •Is there a loan assumption? If so, what does that do to the cash value of the policy?

Because it is a universal life product, the interest return is only one part of the life insurance calculation puzzle. Non-guaranteed expense and mortality charges may vary in the future based on the experience of the company and the product.

1 Comment   |  Flag   |  Jul 09, 2013 from McLean, VA
Xay

Email (handparadise@yahoo.com) to me what your concerns are and what you would like to do. Me educating you is FREE.

Flag |  Nov 18, 2018

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Ross Gerber Level 15

There are many technical parts of your question but to put simply, you can borrow against an insurance policy and policy loans are tax free as they are loans. There are many factors to consider in doing this. Every policy is designed differently. That is the most important thing, having the policy designed right with the correct features. Also, I have always felt the main purpose of life insurance is to protect your family, not as a retirement plan. The most important thing is to work with a good agent that you trust.

Comment   |  Flag   |  Jul 09, 2013 from Santa Monica, CA

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Joe Soto Level 15

Hello Ursula

An indexed universal life insurance policy gives the policy holder the opportunity to allocate cash value amounts to either a fixed account or an equity index account. Indexed policies offer a variety of popular indexes to choose from, such as the S&P 500 and the Nasdaq 100.

I don't know why someone would sell IUL as a "7702 Plan". I would ask what they mean to better understand. But, feel free to read this article as food for thought. https://blog.wealthfront.com/7702-retirement-plan/

No, unfortunately, you may not withdraw money from this account unless you are closing it and you should be aware of any surrender charges that may apply. You may however take a loan on part of the money keeping in mind that interest rates will apply. Also, Michael told you something very important, "if your policy ever lapses for any reason, all of your distributions become taxable".

There are many options other than IUL and I would recommend exploring those options. But talking with a specialist is a must. And I would add this, always read and understand your policy whenever you buy life insurance.

Comment   |  Flag   |  Aug 29, 2013 from Burbank, CA

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3 votes

Ursula,

This is a very complex question, so, I'll try and simplify it the best I can in limited space.

Index Universal Life is merely a Life Insurance product that, instead of using "current market rates", links its return to some index of the markets, most often the S&P 500 Index. The company then credits your account with some percentage of the gain in that index at a preset point in time.

Now, as far as a 7702 plan goes...

IRC 7702 outlines the implications of life insurance contracts, a specific financial product.

It is not a "retirement plan" as some would have you believe. It is merely a section of the Internal Revenue code which defines certain characteristics of Life Insurance.

While life insurance has many good features, it is not, and should not be presented as anything other than what it is.

And, you cannot withdraw your money at 'any time" without penalties, as most contract have huge up front commission, and normally a surrender charge for the first several years.

If you need to save for retirement, first, max out your 401k if you have one... if not, an IRA... only then should you consider this as a savings vehicle.

While life insurance is an important tool in the "Financial Planning" toolbox, it is but that, and should first be purchased to solve a problem in the event of your death.

Proceed with caution... better yet, consult with a local Certified Financial Planner before committing to this... it is a long term proposition... not a "savings account".

Comment   |  Flag   |  Jul 09, 2013 from Springfield, MO

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3 votes

Index universal life is a policy that credits based on a financial index. Though you cash value will not go down in a bad year, in good years there are typically caps on how much growth you will be credited.

7702 is the section of the IRS Code that defines cash value life insurance. Period. There is no scheme for Congress to create a 7702 Plan. To be fair, cash value life insurance has favorable tax treatment, and some consider it the last great tax loophole.

Don't be swayed by a salesman trying to package life insurance as a retirement plan. If you want like insurance, you should buy life insurance. If you want to invest in a retirement plan, you should take advantage of a 401(k) if available. If not, you should start an IRA. Consult a local financial professional, preferably a CFP(R). I would not recommend Ask trusted friends, relatives and co-workers for referrals. A qualified CFP(R) will not only be able to advise you on the best way to save for retirement, but will also be able to advise you on what your actual life insurance needs are.

There are a myriad of rules and tests as to whether it is considered life insurance or a modified endowment contract or ‘MEC’. You can typically only contribute ‘after tax’ premiums, you can only contribute a certain ratio of premiums to death benefit. If you have too much premium relative to death benefit, or if you contribute too quickly, you policy becomes a MEC, and then all distributions become taxable. Your investment choices are limited to what is in the policy, and you cannot change policies as you can IRA accounts.

I would also argue that your target premium might be impractical to maintain a death benefit and still build a large enough cash value to live off of in retirement. Also if your policy ever lapses for any reason, all of your distributions become taxable. The IRS is effectively saying that if you have a life insurance policy with a cash value, you can borrow that cash as effectively an advance on your death benefit.

So let’s say you’re 60 years old, and build up a cash value of $200,000 on your $2,000,000 policy. You withdraw $100,000 to by that sailboat for retirement you always wanted. As you become 66 and 67 and 68 and older, the mortality expense rises on your contract, and perhaps your investments don’t do so well. At some point, your policy runs out of cash value and expires. You have lost your death benefit, and you have a tax burden on that $100,000 distribution that you may have thought was tax-free. The logic for this cause and effect goes back to the premise that the tax advantage stems from this being life insurance; it was not intended for you to buy a boat, or house, or live off in retirement.

View all 4 Comments   |  Flag   |  Jul 10, 2013 from Delray Beach, FL
Michael

Qualified plans have been around for some 30 years. When first enacted tax rates were
significantly higher than they are today and those promoting qualified plans enticed people to participate with the belief that you would gain significant tax savings today and retire in a lower tax bracket in the future so you were enjoying tax rate arbitrage. At the time that sounded logical. Today tax rates have dropped substantially and are at historical lows. With out of control government spending and a dysfunctional congress, many economists and one political party in particular believe that taxes should be increased. For those who have been putting money into qualified plans for the past few years at these low tax rates, they face a very unpleasant surprise when they retire and begin to draw income from their government regulated retirement plan. They will pay taxes on every single dollar they draw from their retirement plan. Original contributions, plus growth. These taxes are unavoidable. Index life on the other hand, when properly funded and structured by a trained agent provide substantial benefits over qualified plans. Among the advantages are: 1) life insurance protection 2) Tax Deferred Growth of funds 3) Liquidity- no requirement to wait to 59 1/2 to access your money. 4) No risk of losing money in the market 5) The ability to access TAX-FREE, non reportable income at any age, for any reason. I often times get the question... isn't life insurance expensive? My response is yes it is, but it is alot cheaper than giving up 1/3 or more of your retirement savings the government. IUL is not a product that be purchased and put in the cabinet and forgotten about. Just like an invgestment it is important to meet with your advisor on a regular basis to evaluate your policy performance. Also not all products are created equal. Only work with an independent advisor who can evaluate different policies and find the one that best fits your needs.

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Flag |  Dec 13, 2013 near Flowery Branch, GA
Patrick

I don't know why people slam IUL so much. I also don't understand why anyone would favor a tax relationship with Uncle Sam over tax-free income. What I do know is that I am pretty tired of people speculating that IUL is going to be worse than other retirement options when you look at all the market risk, taxes and fees. When I was born in '58, the top tax bracket was 91%. Today it is 39.6%. So, my question is how can people talk about what might be with IUL and only address the worst and not do the same for ANY form of investment that is tax-deferred and very likely about to be ambushed by the IRS when (and for me it truly is when) tax brackets soar again. Where is the pay back of our 17 trillion dollar debt coming from? Taxes will be a part for sure and those with some means will feel the bite. One other thing that needs to be addressed. Honest, forthright agents don't show the last 20 or 30 years of the S&P. They show its entire history. Also, you can show 20 or thirty year periods incorporating the best, middle and worst years and you will see some pretty impressive numbers. Every company sells a different product, structures it differently etc. I can just as easily accuse my adversaries of drinking whole life, market or other flavors of Koolaid as we are accused of for having a passion for IUL. We are not talking about selling a minimum premium, target etc. We are talking about maximum overfunding allowed in a non-mec. One last thing. If agents sell IUL honestly, the people who CHOOSE to use them are big boys and big girls and are smart enough to know that there is always a chance it may not perform ultimately. But even if it does mediocre, the tax advantages will still put them in a better place in the long run.

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Flag |  Sep 24, 2014

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