Cassidy Horton is a finance writer covering banking, life insurance and business loans. She has worked with top finance brands including NerdWallet, MarketWatch and Consumer Affairs. Cassidy first became interested in personal finance after paying of.
Cassidy Horton Personal Finance Reviewer and WriterCassidy Horton is a finance writer covering banking, life insurance and business loans. She has worked with top finance brands including NerdWallet, MarketWatch and Consumer Affairs. Cassidy first became interested in personal finance after paying of.
Written By Cassidy Horton Personal Finance Reviewer and WriterCassidy Horton is a finance writer covering banking, life insurance and business loans. She has worked with top finance brands including NerdWallet, MarketWatch and Consumer Affairs. Cassidy first became interested in personal finance after paying of.
Cassidy Horton Personal Finance Reviewer and WriterCassidy Horton is a finance writer covering banking, life insurance and business loans. She has worked with top finance brands including NerdWallet, MarketWatch and Consumer Affairs. Cassidy first became interested in personal finance after paying of.
Personal Finance Reviewer and Writer Ashlee Valentine Deputy Editor, InsuranceAshlee is an insurance editor, journalist and business professional with an MBA and more than 17 years of hands-on experience in both business and personal finance. She is passionate about empowering others to protect life's most important assets. Wh.
Ashlee Valentine Deputy Editor, InsuranceAshlee is an insurance editor, journalist and business professional with an MBA and more than 17 years of hands-on experience in both business and personal finance. She is passionate about empowering others to protect life's most important assets. Wh.
Ashlee Valentine Deputy Editor, InsuranceAshlee is an insurance editor, journalist and business professional with an MBA and more than 17 years of hands-on experience in both business and personal finance. She is passionate about empowering others to protect life's most important assets. Wh.
Ashlee Valentine Deputy Editor, InsuranceAshlee is an insurance editor, journalist and business professional with an MBA and more than 17 years of hands-on experience in both business and personal finance. She is passionate about empowering others to protect life's most important assets. Wh.
| Deputy Editor, Insurance
Updated: Aug 11, 2023, 4:49am
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Internal Revenue Service (IRS) Tax Code 7702 sets the guidelines for determining the tax status of whole, universal life and other types of permanent life insurance. If a policy doesn’t meet the requirements of code 7702, you may be subject to taxes and penalties on loans and withdrawals you make from the policy’s cash value.
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Section 7702 refers to a section of the Internal Revenue Code that limits the amount of premiums you can pay into a life insurance policy without it being considered a taxable investment.
If you pay too much into your policy, withdrawals or loans taken from the cash value could be subject to taxes and penalties—although the death benefit will remain tax free. However, if you stay within the limits set by code 7702, a policy has some valuable tax-free benefits.
The 7702 tax code requirements are designed to ensure a life insurance policy is primarily for a death benefit pay out and not an investment vehicle.
Under Section 7702, a life insurance policy must meet two requirements to qualify for tax-advantaged treatment:
Tax code 7702 applies to cash value life insurance policies, not term life insurance policies.
Wondering if your life insurance policy meets the requirements of Section 7702? You can verify your policy status by contacting your life insurance agent, says Daniel Adams, founder and president of CEG Life Insurance Services.
“When you first purchase a life insurance policy, you can specifically request that your policy remains in compliance with Section 7702,” Adams says. Then, if you ever decide to increase premium payments, Adams recommends consulting with a qualified insurance agent to determine whether an increase would change your policy’s compliance with Section 7702.
To stay compliant under tax code 7702, a life insurance policy must pass one of two tests: the cash value accumulation test (CVAT) or the guideline premium and corridor test (GPT).
According to Adams, the policyholder gets to choose which test they’d like to use, and they typically make this selection when they complete their application.
The CVAT determines whether the premiums paid into a life insurance policy are reasonable in relation to the benefits provided. In other words, it ensures that the policy is not being used solely as a tax shelter.
The test looks at the amount of premiums paid into the policy and compares it to the policy’s cash value. If the cash value exceeds the premiums required at that time to keep the policy funded, the policy fails the test and may lose its tax-deferred status.
In other words, under the CVAT, your policy must not accumulate cash value too quickly. If it does, it will be considered an investment vehicle rather than an insurance policy, and you will not be able to take advantage of the tax benefits offered by Section 7702.
The second test is the Guideline Premium and Corridor Test (GPT). This test is designed to ensure that your policy remains within certain limits in terms of premiums paid and death benefits received.
The GPT has two parts: the Guideline Premium Test and the Corridor Test.
“While in theory, an indexed universal life (or other cash value) insurance policy could fail the CVAT or GPT, which would then cause it to lose the definition (and tax benefits) of life insurance, in practice life insurance companies will not allow this to happen,” says Adams.
Life insurance companies typically conduct routine checks on policies to ensure they comply with code 7702.
Life insurance companies typically conduct routine checks on policies to ensure they comply with code 7702. In other words, if a policy doesn’t pass its designated test, the insurance company will take steps to bring it back into compliance.
Adams gave these two examples of what might happen if a life insurance policy doesn’t meet tax code 7702 guidelines:
If your policy is reclassified as a MEC because it fails to comply with section 7702, you lose certain tax-free benefits on distributions.
Though code 7702 isn’t a life insurance plan—it’s a tax code—it’s sometimes called a “7702 plan.” Non-compliance with code 7002 triggers a reclassification of a life insurance policy to an MEC.
Although an MEC does not have the same tax advantages of a cash value life insurance policy, there may still be ways a MEC can fit into your financial planning. For instance, an MEC might be a good fit for those with specific estate planning goals. If your main intent is to pass on wealth tax-free rather than to supplement retirement, a MEC may be worth considering.
And MECs can be an alternative to annuities in your estate planning. MECs are similar to deferred annuities —both grow tax deferred. But MECs also provide a tax-free death benefit, while annuities become taxable when you die. Additionally, you may be able to earn higher interest on an MEC compared to deferred or indexed annuities.
MECs do not have the same tax advantages as cash value life insurance policies. Distributions will come from the interest on your cash value first, which means money you take out of the policy is taxed as regular income.
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A section 7702 plan is not a type of life insurance. Rather, it’s a section of the U.S. tax code that defines the criteria for certain types of life insurance policies to receive tax-favored treatment. Policies that meet the criteria of section 7702 are often referred to as “7702 plans.”
Neither the cash value accumulation test (CVAT) nor the guideline premium and corridor test (GPT) is inherently “better” for qualifying for tax code 7702. The cash value accumulation test may be better for policies with a higher death benefit, while the guideline premium and corridor tests may be for policies focused on cash value. A licensed life insurance advisor can help you decide.
A modified endowment contract (MEC) is a life insurance policy that fails to meet the requirements of tax code 7702 by exceeding legal tax limits. MECs are subject to different tax rules than non-MEC policies, including a 10% penalty tax on withdrawals made before age 59 1/2.
Tax code 7702 applies to whole life, universal life and variable universal life insurance policies. Term life insurance policies are not subject to tax code 7702 because they do not have a cash value component.
When the Consolidated Appropriations Act of 2021 passed, it made a change to Section 7702 that allows people to contribute more to their life insurance policies without triggering adverse tax consequences. “This mostly impacts high-income earners who are seeking additional tax-savings strategies as this allows them to use life insurance to protect more of their money from taxation,” says Adams of CEG Life Insurance Services.
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Personal Finance Reviewer and WriterCassidy Horton is a finance writer covering banking, life insurance and business loans. She has worked with top finance brands including NerdWallet, MarketWatch and Consumer Affairs. Cassidy first became interested in personal finance after paying off $18,000 in debt within 10 months of graduating college. She later went on to triple her salary in two years by ditching her 8-to-5 job to write for a living.
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