Financial Planning

Save Yourself From Banking on Yourself

Complicated sales pitches often mask "investment" opportunities that are really just insurance under a marketing moniker.

What if we told you there was an investment that...

  • Grows 100% tax deferred
  • Provides 100% tax free income
  • Is NOT reportable to the IRS
  • Pays an average of 5%
  • Allows investors to withdraw money at any time with no penalty, unlike traditional retirement plans
  • Is allegedly used by many bigwigs, including politicians and well-known businessmen
  • Is marketed with lots of capitalized WORDS[i]
  • Is going away soon thanks to the FEDS! So act now.[ii]

All jokes aside, that is a fair imitation of the sales pitch commonly used to dress up a number of otherwise unattractive investment options you would usually ignore. These go by various names: 7702 or 770 accounts, 26(f) plans, "bank on yourself" or "infinite banking" strategies. Let's cut through the glitz and lipstick so you can get a clearer view of these "plans." They are all just costly whole- and universal-life insurance with vastly overstated benefits. Buyer beware.

The first hint to what these are is the array of complicated-seeming names. All are variations on 26 USC 7702-the section of the Internal Revenue Code defining and governing life insurance. Those marketing these policies are just truncating parts of the code section number. In our view, this seems like an effort to make them sound like 401(k) or 403(b) retirement plans-valid, straight-forward, employer-sponsored retirement accounts named according to Internal Revenue Code number. The similarity, it seems to us, is designed to give the product pitch credibility-gravitas.

Unmasked, it's easy to see what these are and understand the limitations. Whole-life insurance is a policy that, intuitively, covers you for your whole life. Get it? This is as opposed to term insurance, which covers you for a specified term (e.g., 10, 15, 20 years). The latter is a cheap option that protects your dependents in the event you die during the term. You pay the insurance company premiums, which it pools with many other folks'. If you die, this pool pays you a pre-determined death benefit. You also pay premiums with whole-life insurance that are pooled to fund a potential death benefit. However, there is no expiration. Because of this, premiums and the cost of insurance are generally substantially higher than term insurance policies.

The high premiums not only fund the cost of insurance, but a portion remains in the policy as a reserve, called the cash value. This is the source of the hype the so-called 770 account or 26(f) plan hinges on.

The idea here is you pay up front-either in lump sum or several payments, establishing a relatively substantial cash value. Premiums are deducted from this over time, with the balance sitting like a fixed annuity within the overall policy, earning interest at a pre-determined rate and growing tax deferred. The 5% cited in our mocked-up pitch is a common claim, but one likely overstating reality these days. Insurance companies probably won't credit your policy with more interest than they can reasonably earn by investing your premiums, and in today's low interest-rate environment, that isn't high. It is theoretically possible to buy a policy that bases interest rate credits on an equity index, but like equity-indexed annuities, the return caps and calculations usually result in CD-like results, not stock market-like results. Others may deploy subaccounts-mutual fund-like options that move with the value of stocks, bonds and other securities they invest in. But these are often high fee on their own, mitigating return.

You can access policy cash value, which is the source of that tax-free income statement. But there is a caveat. You have to borrow your own money-paying the insurer interest, further weighing on your return-in order for it to be tax free. (This is also why the activity isn't reported to the IRS-it's a loan.) Hence, whatever interest rate you are credited will be further reduced. Withdrawals are potentially taxable events, if you take out more than you put in. If you're under 59½ years old, gains are possibly subject to an additional penalty. That is reported to the IRS. Finally, if you deplete the cash value too much, it may not cover the premiums due to keep the policy afloat, causing it to lapse.

The time to be aware of these limitations is up front. Before you buy. Like many insurance products, once you're in, there are stiff penalties called surrender charges for leaving. The insurer usually pays steep commissions to salespeople for pitching these products, and the back-end charge is there to recoup the money if you decide to leave within a few years of buying. Said differently, when you realize the sales pitch we mocked up early in this piece isn't the full story and want out, big exit fees make you think twice. Banking on yourself with a 770 account or 26(f) plan likely actually means getting a very low return on a high-fee product. Save yourself the trouble and look elsewhere.

Hat Tip: RJ Miller, Fisher Investments Annuity Counselor

[i] Adds to the urgency, you know.

[ii] This is actually used in sales pitches, but it isn't accurate. Most often, the peddlers of these strategies claim that the dates of proposed rule changes (like the Department of Labor's fiduciary rule) will eliminate these as a way to get you to ACT NOW!

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.