Before You Rollover Your 401k Into an IRA, Consider Tax Rule 7702

The conventional wisdom when you leave a job is to find a IRA advisor and rollover your 401k to continue the tax deferral benefits of an IRS qualified retirement plan, but more and more Americans are taking the time (and considerable effort) to set up a new IRS approved Private Plan retirement account under tax rule 7702. Properly structured there is no other retirement program like a 7702 Private Plan.

Properly structuring a 7702 Private Plan is not for the faint of heart, the first and most important step is finding a qualified and experienced advisor. A 7702 Private Plan pays about 80% less commissions over a 10 year period than the average IRA account so most financial and retirement advisors won’t even tell you about this plan because it will mean a big pay cut, and even fewer advisors have the skills or know how to set one up properly in the first place.

Comparing a 7702 Private Plan to other traditional IRS Qualified retirement programs apples to apples is quite difficult for most people without the understanding of what you are getting out of your Private Plan. The first hurdle is to understand that contributions to a 7702 Private Plan are taxed similar to a ROTH IRA, so at first glance it may seem that you are losing a lot of money by making this type of a rollover and paying all the deferred taxes. Unlike traditional IRA, 401k and other plans, income from a 7702 Private Plan is tax free and is not counted as income to calculate Social Security taxes.

Most Americans will simply pay a much larger tax bill at retirement in terms of actual dollars paid by deferring taxes in a traditional qualified plan than if they were to just bite the bullet and pay the taxes now. One noted author on the subject who wrote the book “Last Chance Retirement” asked the question “what would you rather pay taxes on, the seed or the harvest?” The other hidden tax trap in most traditional IRS Qualified Plans is how the income from these plans increases the taxes on Social Security benefits. As a rule income from traditional retirement plans will count towards the taxation formula on your Social Security income, and tax your Social Security benefits up to 85%! Not only are you paying much more taxes in total dollars with a traditional tax deferred retirement account, the income you receive is increasing the taxes you will have to pay on your Social Security income.

With only a few exceptions, 100% of the income from a 7702 Private Plan is tax free, and unlike income from traditional retirement plans, 7702 Private Plan income is not considered when determining the taxes you will have to pay on your Social Security benefits. Over a 20 year retirement period this can account for a significant amount of money.

Risk is another factor to consider. Recently we have seen tremendous losses in the stock market which has erased trillions of dollars in market value and reduced millions of American’s retirement accounts, some with losses exceeding 50%. Properly structured, a 7702 Private Plan will earn returns based on a widely recognized stock market index. If the market index (let’s use the S&P 500 as an example) goes up 10% in a year, then your account is credited 10% interest for that year. But if the market loses 10% during that same time, your principle balance and any credited interest in a 7702 Private Plan is safe, the account is simply credited 0% interest for that year (some 7702 Plan Administrators even give you the option to choose a declared fixed interest rate each year on the plan anniversary date, this is a useful option if you think the market is going to perform less than the declared rate for that year, when the market index begins to show life again you simply change crediting methods to earn the market based returns, either way in a properly structured 7702 Private Plan you can never lose your principle or credited interest due to market losses) Once again there isn’t nearly as much commission in a 7702 Private Plan compared to most traditional IRS Qualified plans, so don’t be surprised that your advisor hasn’t told you about this heads you win, tails you don’t lose investment strategy. For more information about the no market risk index strategy available in a 7702 Private Plan click to view this graph.

There are additional ‘living’ benefits that can only be found in a 7702 Private Plan. State and Federal Law requires that a 7702 Private plan be administered by an insurance company licensed to do business in your State. This is because Congress mandates that a minimum Funding Guarantee Benefit be included in every 7702 Private Plan to qualify under IRC 7702. This means that if you were to pass away prematurely, your surviving spouse would receive a tax free payment of approximately what you would have saved had you lived and continually contributed to your Private Plan until retirement. Several Private Plan administrators are now offering 7702 Private Plan accounts that include a Flexible Guaranteed Funding Benefit where if you experience certain medical events in your life the entire benefit is available while you are alive.

Moving into retirement the Flexible Guaranteed Funding Benefit in some 7702 Private Plans will even allow for access due to Long Term Care needs. One company makes 2% of the entire Flexible Guaranteed Funding Benefit available if you are diagnosed as being unable to perform 2 of the 6 activities of daily living. This benefit in a 7702 Private Plan is nearly identical to having a built in Long Term Care insurance policy at no extra charge. For example, if the Flexible Guaranteed Funding Benefit is $450,000, then 2% per month would equal tax free payments of up to $9,000 for long term care needs. If you haven’t priced long term care insurance recently then you are in for a shock, this stuff is expensive but it is built into several 7702 Private Plan retirement accounts currently offered by approved 7702 Private Plan administrators at no charge.

For most people setting up a properly structured 7702 Private Plan is actually very easy once you locate an advisor who knows how to structure it correctly. You do have to qualify for the Guaranteed Funding Benefit with a physical exam just like any life insurance application, and there are IRS rules on rolling the funds into the account, but once you have set up a 7702 Private Plan it will be there to grow your retirement savings based on market gains but without market risk and will keep your family safe from other financial hazards for your entire life.

No other retirement plan offers benefits like a 7702 Private Plan and no other traditional plan gives you the upside potential of the market without any of the associated market risk. On May 16th of 2008 the S&P 500 closed at 1425.35, today (1-27-2008) the S&P 500 index closed at 845.71, if your retirement account was in a 7702 Private Plan you would still have all of your original investment plus any credited interest the account had received. Then on Jan 27th 2010 say the market closes at 930.28, while everyone else is still at severe losses your 7702 Private Plan account would be credited 10% interest on the entire original balance plus any previously credited interest.

The downside protection with upside market potential and a host of ‘living’ benefits in a properly structured 7702 Private Plan is worth the effort to find a honest advisor who is willing to help you create and administer a 7702 Private Plan for life.