You may have seen ads talking about "secret 770 accounts," financial vehicles that let you retire 100% tax free, are not reportable to the IRS and never go down in value. Many of these ads have a tone that says "scam" to the more cautious investor. While it is not fair to call them a scam, it is also not fair to call them retirement programs — and, arguably, they should not be called accounts either. They are simply a form of permanent life insurance used more as an investment than for the traditional death benefit.
The name 770 account (sometimes they are referred to as 7702 accounts) is derived from Section 7702 of the tax code which concerns the rules regarding the taxation of life insurance policies. The marketers promoting these policies use these names presumably to equate them to 401(k) retirement accounts that also get their name from the tax code. More importantly, they also avoid initially calling it life insurance as many people respond negatively when “life insurance” is mentioned or discussed.
With permanent life insurance policies, death benefits are tax-free and the interest and gains in the cash value account are not included in the policyholder's current income. However, in these strategies the death benefit is lowered to minimal levels, making the cash values grow faster such that the policy is clearly more an investment instead of a traditionally designed life insurance policy. Thus, you could have a more stable cash value build up with the tax-free access to the money.
In Section 7702 the IRS draws the line that identifies what can qualify as life insurance and still maintain the tax benefits of life insurance. 770 accounts are merely overfunded life insurance contracts that, if properly designed, take you right up to that line without crossing it. There is nothing wrong with that — that is why the line exists.
Newsletters touting 770 accounts point out that big banks have millions of dollars tied up in these investments, and the extremely wealthy can use them as tax shelters. Are you extremely wealthy (or a big bank with thousands of employees)? If not, that is really an irrelevant selling point.
The more money that you can devote to this form of “investment”, the more likely it is to make sense to you because of the tax sheltering aspects of life insurance. At higher income levels, limits on IRA and other retirement contributions may make 770 accounts far more attractive compared to other options. However, you do not care how it affects big banks; you only care about whether it makes sense for you.
As stated above, a 770 account gets as close to the line of an investment as possible without crossing it. Essentially, your life insurance policy is "overfunded" to the fullest extent possible while at the same time minimizing the death benefit. Over time, the growth allows the policy to provide tax-free access to higher cash values to fund retirement costs.
Meanwhile, you do receive interest credited to your cash value account. This constitutes the yearly payments that 770 pitchmen refer to. Again, there is nothing special here; that is how life insurance works. You have a choice as to how your cash values are invested. You can use either a fixed, variable or indexed crediting method to determine how your cash values will grow. In my opinion, you can use either a fixed or indexed method but you should stay away from using a variable policy as these will subject your cash value to losses. Other than the tax advantages, the ability to avoid market risk and still grow your money is a significant additional advantage of using life insurance to save for retirement.
Also consider that it takes time for life insurance policies to build up sufficient cash values to meet your objectives — the older you are, the less this form of investment makes sense. Unfortunately, as it is being pitched as a safe retirement program, this aspect can get lost in the marketing.
Since 770 accounts are individual contracts with an insurance company, your agent should help you understand the fees and costs associated with the policy, as well as the interest rates that are charged when borrowing against the policy (guaranteed or variable) and what happens if premium payments are late or missed. Please understand that there are significant differences between universal and whole-life policies but this comparison is beyond the scope of this article.
Life insurance contracts used as an investment are expensive in the short-term (especially if cancelled early) and comparatively inexpensive in the long-run. Either way they are profitable for insurance companies — that is why they sell them. You must compare using life insurance against other uses of your money such as investing in an IRA, 401(k) or other more traditional retirement programs.
My advice is not to sign anything until you can do a complete cost-benefit analysis, compared to an alternate use of your money (do not forget any life insurance needs you may have). Also, make sure that you understand the fine print of the contract regarding the possibility of interest rate or crediting rate changes or what happens when the money is withdrawn. If you cannot do that analysis on your own, seek the advice of an independent financial planner or get your CPA involved in the discussions.