Attempt to recruit to MLM team and conversation about 7702

Note: This is a copy of the chat with someone about Roth, taxes, and 7702. It was turned out to be an attempt to recruit into MLM insurance company. The interlocutor's arguments are in bold. The conversation has been edited, and minor clarifications have been added (in parentheses).

I occasionally get on the 401K group site, but I see you are very active and assuming you have a passion for investment. Good for you!

I think more Americans need to save and learn how to invest and manage their finances, and glad to see people asking questions; and you are doing a great job sharing and helping.

I believe taxes will go up, and keeping everything in taxable accounts is not a good idea, and Roth is also limited. You commented on one of the posts, so I wonder how much you know about tax-free vehicles and your thoughts on that?

Where are you from? I am from ABC originally. Being an immigrant and working in international trade with people from different continents, naturally drawn to people from other countries.

I am pretty knowledgeable about Roth. Do you have a specific question? I will try to clarify.

I know Roth is very limited, and you can only do so much a year if you qualify, and if you make over a certain amount, it is no longer tax-free. How does the backdoor work?

And what do you know about 7702 (Life Insurance)? Your thoughts on that?

Backdoor allows contributions to Roth IRA even for high earners. You put money to a traditional IRA first, do not ask for tax-deductions, so after-tax money, you convert traditional IRA to Roth. You should be careful if you have pre-tax money in any of your IRAs.

Many ppl have access to employer-sponsored 401k, or themselves may qualify to open solo-401k or SEP. Those plans allow much higher contributions, including Roth.

Essentially one could open a new traditional IRA with after-tax money and then convert to Roth? What are the rules, such as the amount allowed to contribute each year into this traditional IRA, and amount allowed to convert to Roth, and when can you do it?

Limits on contributions to traditional IRA is as for IRA in general: $6,000 annually. If you are 50+, the limit is $7,000.

No limits on Roth Conversion: perform conversions to Roth whenever you want, pick any amount you want, no constraints.

If you already maxed out on your 401K each year, can you still contribute to this traditional IRA with the intent to convert to Roth?

Correct. You might not be able to ask for tax-deductions, but you do not need that.

Thank you! What are your thoughts on 7702? It seems to be a good vehicle for tax-free earnings and distribution, downside protection, family protection, and flexibility. Particularly if one already has money in the market, 401K, and the rest in a bank that does not earn much. What do you think?

A good way to diversify if one puts a portion of the asset there.

So if you max out Roth and 401k, we are talking about $19.5K + $6K = $25.5K a year, partially is Roth (or even all). Not many employees may put even more. We are talking about very high earners. Income should be higher than 100K.

Yes and no. Here is what I see this vehicle can help and let me know if you agree as I have been learning about it :

1. For people who have the extra money after maxed out all the above and more cash sitting in the bank earning nothing.
2. For people who may not want to defer tax only and rather may have more tax-free because tax could be higher later, look at all the money being printed now and where the country might diversify and balance.
3. For people who are over 50 and want more downside protection and estate planning, and LTC.
4. A younger family without a lot of savings yet but need family protection in the event something happens to the breadwinner, college education, down payment for a house, and then retirement... It seems to offer that flexibility but better interest than banks.

I think it serves the purpose, no?

Only if you have a high income, right? So you put $25.5K; it is already high. It means your income is $100K+. We are talking about a small fraction of ppl who earn more than $100K and can potentially save more than $25.5K.

(3) When you are 50+, cash-value insurance will be very costly for you. Probably it will elapse. Too late to start such a product. For old ppl, it might be too late to think about LTC. Hopefully, they have a property and, in the worst case, will use "reverse mortgage."

Remember that long-term capital gains tax is very favorable: 0% or 15% for most ppl.

Estate planning is not relevant much since you have:

1. Estate tax exempt: $11M.
2. Step up in basis.

Risks against the market could be mitigated with properly constructed portfolios with defensive assets, like bonds.

1. How do you mean by the long-term gain tax is 0-15%? I heard "step-up in basis" might change too.
2. For people who have extra money, I think it is good to allocate a portion to 7702, agree?
3. And not just for wealthy people, for professionals and couples both working, if people plan early and properly, they can have extra money each month and likely just put in the bank, in such cases, 7702 is a better option; many do have the plan. I just talked to a friend in her late 40's who had it for 14 years in addition to 401k and Roth; they are professionals. If people are in a lower tax bracket now (as some professionals), then isn’t that even better to put some money tax-free now because the tax will likely increase later. So too much tax-deferred might not be the best option.
4. 7702 is income tax-free. Some states don’t have an estate tax or inherit tax, but they still have to pay income tax, no way around that other than 7702. Plus, you have the flexibility to use the fund for living benefits, including LTC, withdraw without paying tax for an emergency, using it as collateral for buying a house to get lower interest, and no 59.5 age limitation... And you can start tax-free savings for kids at 0 age when they can not have Roth.
5. For younger people or even people at 50 but healthy, if structured properly, the cost can be lower, or they can accumulate the cash value to essentially fund their own policy later, which will reduce the COI (Cost Of Insurance) as they get older to avoid lapse or use it as retirement income. Younger people can take money out for education, better than 529 when it is limited to education and still be considered an asset when applying for financial aid, but 7702 is not counted as an asset. One can use the money for an emergency, including unexpected illness even when you are young, and what happens to the family with three kids if the breadwinner is gone at a young age and doesn’t have many assets? We don’t know what will happen; I think this vehicle can offer the DB (Death Benefit) plus living benefits with protection, flexibility, liquidity and tax-free, and peace of mind. However, it must be structured correctly. And the broker must be knowledgeable and have the best interest in the client. Otherwise, as you said, it can lapse.
6. Real estate- I even considered that myself with my house, but really didn’t want to deal with the renters and glad I didn’t. With COVID, I would have lost money as many probably won’t pay rent, plus I don’t want to have to deal with fixing things. Unless you have a lot of money to invest in bunch properties, for most people who may have one or two houses to rent, the average return is not more than 5% or so if lucky, but a lot of headaches or expense. If I can earn that or more in 7702 and worry-free, why not?
7. Medicare does not pay a lot of LTC either. With 7702, they have the flexibility to use for different things.
8. If all assets are in the market, bond, or real estate, you might have to sell with loss when needing the money right away, not very flexible.

I bought an IUL several years ago without really understanding the ins and outs, other than for the DB for my child, moderate risk tolerance, downside protection, tax-free and LTC, and retirement. My average return has been 8%, and my 401k moderate portfolio is just slightly better, but that is before tax. I just started to learn about it and wondered if I should allocate more money there, putting in less in 401K. I have been trying to find the Cons with the strategy, and so far can’t think of any.

I have a good insurance broker, knowledgeable in her field, and very honest, and just in case she is biased, I am trying to get other opinions to make sure. With COVID, some of her clients had to use the policy for death and layoffs; it is sad but thank god they had it!

I see you are an engineer? Since you are so knowledgeable, why not become an advisor?

1. If you invest from a taxable account and hold long-term, your gains will be taxed as long-term capital gains, which is either 0% or 15% (for very high-income earners, it could be 20%), which is not bad actually. Not tax-free, but much better than deferred income tax. You can think about it as a 1% management fee for 20 years. Step up in basis may change, but we hear about this for a long time. Everything may change. How critical is it for most ppl? I am not sure.
2. If you have free money, you have many options; it really depends on your personality. Some ppl will actually prefer real estate, other their own business; others will put into the market. Maybe for you, it is better to use 7702. I do not think there is a general rule applied to everybody.
3. Professionals both working probably have two 401k plans and two IRAs, maybe even with 401k matching. So we are talking about 2 * $25,500 = $51,000 a month, part of this (or everything) could be in Roth (IRA and 401k). If self-employed professional (working on 1099 or owning a business), may open SEP-IRA or solo-401k and contribute up to $57,000 (could be everything in Roth) per year, per person. If one reaches 50 years old, the limits are higher: Roth IRA: up to $7,000, employee contributions to 401k: $26,000, total contributions to solo-401k/SEP: $63,500. So it is really huge. I do not think many professionals can max out all the accounts and still have much cash left. Anyway, 7702 is one of the options, but not only. Some ppl may prefer other vehicles. Especially for 50 years old, 7702 may become very costly and may not accumulate enough cash-account to cover DB (Death Benefit). Definitely, I agree; for those who are in a low tax bracket and expect an increase in income in the future, it is better to max out Roth IRA and even Roth (solo) 401k. But I believe not many ppl will be left with significant cash to put in 7702. Again, I am not saying it is bad; I am just pointing out that it may work only for a small fraction of ppl. I agree that starting 7702 (especially IUL) sooner is better than starting it at 50+.
4. Let me clarify about estate tax exemption. There is currently an $11.58M estate tax exemption per person (adjusted each year). So basically, no estate tax on assets valued less than $11.58M. For two spouses, the estate tax exemption is doubled. Yep, this could be changed in the future. Current tax rules apply from 2018 to 2025. If no other tax reform is accepted, we return to the previous estate tax exemption: $5.49M per person, which is still high for most families. There is also a state tax exemption, which is usually much lower and state-dependent. And on top of this, there is a step-up in basis, already discussed, and yea, there is a risk that it may be changed. But for now, kids will inherit the assets (securities, stocks, funds, etc.) with a cost basis set to the fair market value at the day of inheritance. So basically, it is tax-free inheritance (at least for inheritance lower than estate tax-exempt). When comparing 7702 with other options, such as Roth or taxable accounts, you should remember that the growth in 7702 is lower and the cost is higher. So you basically get lower capital, which is in some sense, like a tax or loss, compared to the best possible performance (tax-free + low expenses)—fees: 1% a year, accumulated in 17% of losses within 20 years. Whole Life growth is on average 5% a year, IUL is 6% a year, the market growth is 7% (on some long intervals, it could be 8-10%). So basically, long-run, 7702 will underperform the index fund, especially when all fees are accounted for, and in most cases, even after taxes are applied. Yep, taking the money anytime you want and still keeping DB is a good feature. But you probably can achieve this with Term Life. BTW, 7702 with the same high DB might be very costly, even for high earners (they might not be able to overfund it). So a solution combining 7702 and Term Life (or Blended Life) may work much better than "7702 for everything". I accept the benefits that 7702 offers, point to other alternatives (like reverse mortgage, Roth, solo-401k, invest from taxable accounts, Term Life, etc.), and emphasize each option's cost. 7702 is not for free, and it underperforms the market.
5. 529 is considered a kid's asset, so it has minimal impact on financial aid. Anyway, due to high commissions, 7702 will take a long time to break-even to the cash sitting in the bank account. If parents start 7702 close to college time, they might find less money in 7702 than they could have in a bank account by the time they need the money. Actually, 529 also has issues when the investment horizon is short. You should pick a conservative portfolio and, ideally, have more than one kid, just if some of them will refuse to go to college. When considering nonqualified withdrawals from 529, we should compare taxes and 10% penalty on the growth in 529, with fees and lower performance in 7702. Nothing is free; actually, each option has its own cost. As I mentioned, 7702 is partially liquid since, in the beginning, you have less than you put. And later, you have lower growth than in other investment vehicles. And if 7702 has poor loans (the way you technically get tax-free withdrawals), you might get high fees while using the money. Again, I cannot claim it is tax-free in this case. I may agree that "properly structured 7702" may work much better than poorly structured and that clients should work with knowledgeable agents/brokers. The problem is how to find one? Basically, every professional makes the same claim: "7702 must be properly structured, you must work with a real professional". But if each agent/broker is proficient (everyone claims the same), why do we see so many policies structured obviously wrongly? Why were any policies wrongly targeted? Why so many policies elapsed that no ppl do not want to hear "cash-value life" and the insurance industry market the product as "Super Roth'', "Roth for Reach'', "7702 for everybody", etc.? And yep, I may agree that there is a way to structure it better, and there could be professionals who can do this right, but the questions are still left unanswered, how an average client may find a good agent (there are about 1M insurance agents!). Compare it with the alternative advice like this: "Contribute to 401k up to matching, open Roth with BBB stockbroker, max it out, put into a target-date fund or balanced fund or use robo-advising". This may work well for many ppl. While 7702 — you must be fortunate to find a good agent who knows what he/she is doing :-) Actually, insurance companies may change the policy parameters (discretionary); for example, for Whole Life, they may reduce dividends, while for IUL, they may reduce the max-cap or the participation rate. Not sure how to address those risks if they really exist. Some, but maybe not all, benefits may be achieved with Term Life. Anyway, if someone needs $2M DB, it is hard to achieve this only with 7702; you probably need Term Life (or Blended) anyway.
6. Real estate gives huge tax benefits, but it really depends on the particular person and situation. Some RE investors do not want to touch the stock market. Other investors do not want to deal with RE. Very personal decision. The same as starting your own business.
7. Yes, I agree, LTC is important. Again the question is about the cost and other options, like reverse mortgage, investment, etc. LTC might be critical at the beginning when there is no sufficient capital while it happens that you or your spouse need LTC. 7702 may cover more than what you saved in the attached 7702 cash-value accounts.
8. Agree, but note that investment-grade bonds do not fall much during market downs. Yep, investors should have an emergency fund and create investment portfolios created according to their individual risk tolerance. It is not easy to implement, but probably easier than to properly design 7702. I tend to agree that the conservative portion of your investment portfolio or some portion of the emergency fund could be stored in 7702. But not everything, and it really depends on the risk tolerance of the investor. Anyway, you might need a combination of WL, IUL and it will still not solve the problem of high DB, so that Term Life might be required anyway! And I emphasize 7702 may be part of an investment portfolio. Still, it is very individual, probably the combination of the following factors should apply: high-income earner, maxed all retirement accounts, low-risk tolerance, with Term Life/Blended, relatively healthy/young, have a good emergency fund, etc.

I do not think 7702 is a horrible product, but it is essential to put it in the right place in your portfolio. IUL underperformed index mutual funds in many of my simulations, even when taxes are accounted for (but not fees!). On the other side, IUL has a lower correlation with the market (WL is even lower correlated), so it could be placed in the portfolio as another asset type. By the end of the day, in addition to stocks, investment portfolios usually contain bonds, commodities, cash, etc. Some investors may like this since each class has a different correlation with the market.

On the other hand, aggressive investors, who do not use defensive assets and are 100% in stocks, may not find 7702 that much attractive since it will underperform the market.

Also, older ppl may find 7702 too expensive since, inside the policy, it uses ART (Annually Renewable Term Life), which becomes extremely expensive after 50. Actually, most 7702 policies assume that the accumulation phase ends at 65 or 75.

Ppl who could not max out Roth and 401k might not be able to overfund 7702, increasing the risk of policy lapsing (and an agent may leverage such clients). Yep, in some cases, the 1035 Exchange may help, but you will probably start over, paying front-load fees to the new agent or might not be insurable by that time.

Not many agents are trying to design a combined solution of 7702 + TL or with Blended. They are not trying to reduce the fees; they probably do not know how to do this with their software. Break-even points might be very far, which may make ppl unhappy, and the policy is less useful for the short-run.

1. I am still unclear how you can have long-term gain tax at 0-15%. How do they determine what is a long-term gain and what percentage of tax you must pay?

Capital gains are considered long-term if you hold the asset longer than 1 year. Otherwise, it is short-term capital gains, which are taxed as ordinary income.

I agree 100% that each product has its own purpose and people have to know if that is what they want. I agree 100% that it is tough to know how to find the best person you can trust and that they will always put their client's interest first, plus knowledgeable, credible, and personable—someone who really cares. I also believe that people should try to get financial education themselves. I have been in sales (B2B) for many years, and integrity is so important. I would rather lose the sale than selling the wrong product to my customers. Reputation is everything. I never worry about making a sale, rather I enjoy helping my customers find the solutions, and sometimes, it may not be my product, and that is OK. Even the best product can't fit everyone.

When it comes to people's finance, that is very personal, and you can change people's lives for better or worse. I was not clear how you mean by leaving the bank's money could be better than in IUL? I think there are different ways to address the cash and age issue, and if people are interested in learning more about how and if it can fit into their plan, I would love to connect them with my friend who can help explain and educate least. By the way, why are you not in the financial business? What do you think about the video (Ed Slott, CPA Life Insurance for Life Beyond)?

I saw this a long time ago. :-) Sales pitch. Is your agent from Yet-Another-MLM-Group?

Actually, Yes. I think she is in $$-rica, why do you ask? I really like her, very professional and caring and her team has some really sharp people, all with two or three degrees, they seem to have done some really in-depth analysis from different companies... By the way, I meant to ask you which robo-advising do you recommend? I am not interested in paying another advisor right now as I really didn't see much value.

Robo-advising? Betterment is probably the best. Maybe if she is in the FB group, I may connect to her?

I don't think she is on FB; I don't use FB a lot either. I actually think you would be very good at it, you already know so much! I attended her zoom meetings and met some of the people; I was quite impressed.

They have a board who does a lot of research on products and things; I think quite a few are IT people, even PhDs or professors in Universities, all professionals. I can see you being on that board since you are so technical and knowledgeable.

I know they would love to work with you! It has been such a pleasure talking to you, and thank you so much for spending time to share.

I found out that my agent does have a FB account but not very active. Would you like to connect with her?

It’s not urgent, it’s fine. Do not worry; I will keep learning the topic.

I spoke to her, and she is interested in “meeting you.” I told her how impressed I was with you. Have you worked with other agents in CA?