What is 7702 life insurance?
Cash value life insurance policies are sometimes referred to as 7702 life insurance. This just means that they’re compliant with section 7702 of tax regulation. Life insurance policies have a variety of tax benefits, such as the death benefit paid to beneficiaries being free of income tax. Section 7702 was created to limit what could be considered as a life insurance policy and make sure other investments weren’t reaping the same tax benefits.
Premiums for cash value life insurance can be incredibly expensive, so it’s important to understand all the ways you can take money out of your life insurance policy. Whether you want to get rid of your coverage and cash out your life insurance or simply take out a loan, there’s a variety of ways to take advantage of your policy’s cash value.
Even if you no longer want coverage, make sure not to let your policy lapse at any point. When a policy lapses, you lose the death benefit as well as any cash value you could have been paid.
Pay your premiums with the cash value
Variable and universal life insurance policies are often favored because they allow you to use the policy’s cash value to pay premiums. This strategy will only work for a short period of time if you start while the cash value is too small or if interest rates are low. In addition, you have to carefully monitor the cash value to make sure it doesn’t drop too far, or you may lose your coverage. But if you have a fairly large cash value with consistent returns, you can keep coverage in place for years at little to no additional cost.
For example, say your annual premium is $5,000 and you have $100,000 in cash value. You would just need the policy’s cash value to return a net 2.5% interest annually to cut your premium payments in half while maintaining the full cash value.
Whole life insurance policies typically don’t let you pay premiums using the policy’s cash value except if you convert to a paid-up policy. Not all insurers offer this option but, with a paid-up life insurance policy, the cash value is large enough that you can stop paying premiums out of pocket. You use the cash value to pay premiums. The downside to paid-up whole life insurance policies is that each premium payment is deducted from the policy’s death benefit. In addition, less cash value is available for other purposes, such as a policy loan.
Put up cash value as collateral to borrow from your insurer
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A life insurance policy loan is a loan from the insurer in which the cash value of your policy is used as collateral. It can be used for paying medical expenses, buying a car or anything else you might need cash for. Since the insurer holds the funds to cover the loan:
- There are no underwriting requirements
- You can keep the loan outstanding for as long as you want
- There’s no credit check, and the loan doesn’t appear on your credit report
However, if you pass away while the loan is outstanding, the value of the loan will be deducted from the death benefit your beneficiaries receive.
Borrowing against your policy’s cash value is simple and typically comes with quite low annual interest rates. But you need to either pay interest out of pocket annually or carefully monitor the size of the loan as compared to the policy’s cash value.
If you don’t make interest payments, the interest amount is added to the outstanding loan balance. If the total size of your loan ever exceeds your policy’s cash value, the life insurance policy will lapse, canceling your coverage. In addition, you will likely have to pay income tax on the loan.