7702: A Number to Know About Now More Than Ever

From 401(k) to 529 to 403(b), numbers such as these are often related to retirement, tuition, or other savings vehicles. It's smart to learn about them regardless of your age, as you may very well rely on one of them some day — if you're not already.

But there is another number that is well worth remembering: 7702. While it too has to do with money, 7702 gets its name from the Internal Revenue Code section that outlines what criteria must be satisfied for policies to qualify as life insurance with all its tax benefits.

Here, we'll explain what Section 7702 says, why it matters, what led to its creation and how recently passed legislation on Capitol Hill related to this code may affect cash value life insurance policies moving forward.

What is Section 7702?
Section 7702 is a regulation codified by the IRS that specifies what qualifications cash value life insurance policies must satisfy to be considered "tax-advantaged." As opposed to term life which generally provide no cash value and is designed to provide coverage for only a limited number of years, cash-value life insurance policies can provide coverage to age 100 and beyond. The most typical cash-value contracts are commonly known as whole life and universal life.

Why was Section 7702 even put in place?
Section 7702 traces back to the 1980s and was installed largely as a result of buying trends among individual policyholders and certain businesses that made them available to their employees as a benefit. These policies were generally overfunded to the point where they looked more like a tax advantaged investment than a life insurance contract. 

As noted by Bankrate.com, cash-value life insurance gained a fair amount of notoriety during this decade for the tax perks that came from these overfunded contracts. To limit what it perceived was an abuse use of life insurance, the IRS installed Section 7702 so only by meeting certain qualifications would the policy enjoy the tax advantages of life insurance.

So what?
But with the Consolidated Appropriations Act, 2021 (CAA) now signed into law, the policy qualification tests under 7702 are changing for the first time.  

"There hasn't been a change in the 7702 minimum interest rate calculation since the regulation was originally installed."

For the most part, the CAA was passed as a mitigation measure to recover from the economic effects COVID-19 unleashed on the country and its small businesses. But within the bill was a stipulation that had significant implications for new life insurance contracts. According to Insurance News Net and Moody's Investors Service, there hadn't been a change in the 7702 minimum interest rate calculation since the regulation was originally installed in 1984; signatories believed it ought to be updated to "reflect the current lower interest rate environment."

Under the previous iteration of Section 7702, the guaranteed minimum interest was based on a flat 4 percent. But with the rule change, the guarantee slips to 2% for 2021 and will adjust after that. The lower rate went into effect on Jan. 1, 2021 and seemed to catch the insurance industry by surprise as very few companies have yet to modify their existing life insurance products or released new products taking advantage of the revised calculations.

What are the repercussions?
Some have described the change with 7702 as both a challenge and an opportunity for the insurance industry since the revised tests allow for less death benefit per premium dollar and still qualify as life insurance.  However, it quickly became apparent that the revised 7702 regulation is a "two-edged sword." The immediate challenge to the industry is that since many life insurance designs are minimum death benefit oriented to allow for the best possible cash accumulation, the new smaller death benefits under the revised 7702 calculations will directly reduce agent compensation. Without any adjustment by the life insurance companies, the financial service industry is certain to see increased financial challenges based on reduced revenue. With the prospect of less compensation, it will also be increasingly difficult to attract new talent into the industry. But at the same time, there is opportunity for policy owners to enjoy the benefits of a life product that could potentially be more efficient and produce more tax advantaged cash values than before. 

If you have questions about Section 7702 and how it affects premium financing, Global Financial Distributors has answers. Contact us today.