One of the benefits of life insurance are the tax benefits it can provide you and your family. In addition to a death benefit that typically passes tax free, the cash value of permanent life insurance grows tax-deferred and will never be taxed so long as it stays in the policy. Section 7702 of the federal tax code defines rules about how life insurance qualifies for its tax benefits.
Section 7702 has been in the news lately because the government recently changed the rules that surround it. But what exactly did lawmakers do? It gets complicated quickly, but to help you better understand it, here’s a simplified explanation.
THE 7702 CHANGE
In a nutshell, 7702 sets limits around how life insurance policies must be designed in order to qualify for their tax treatment. The rules in section 7702 are designed to put financial limits on what qualifies as permanent life insurance. Life insurance policies that don’t meet the criteria are not considered “life insurance” under the tax code. As a result, any cash value gain in the policy would be subject to immediate ordinary income taxation on a yearly basis, regardless of whether or not you withdraw it from your policy.
Over time, as interest rates have fallen, insurance companies will be required by regulators to hold additional reserves. The costs of funding those reserves would have ultimately trickled down to policyholders because the rules in section 7702 prevented life insurance policies from building additional cash value based on what you pay. The change to 7702 removes inconsistent limitations, allowing the cash value growth to more adequately reflect the price that you pay for your insurance.
WHAT WILL CHANGE … AND WHAT WON’T
The change will allow life insurance policies to build cash value in a way that continues to reflect the premiums you pay — it’s really that simple. It will allow life insurance to continue to provide exceptional value as part of your larger financial plan.
What won’t change — at least at Northwestern Mutual — is our commitment to managing the company in a way that allows us to stand behind its guarantees for decades to come. Northwestern Mutual is the only life insurer to have the highest available financial strength ratings with a stable outlook. We’re one of the strongest companies in America because of the way we carefully manage our business. We will continue to manage the business with the same care and to treat life insurance policyowners fairly and equitably.