What's a 7702 Insurance Plan, and How Does it Work?

Dear Dr. Don,

My neighbor keeps telling me about investing in a 7702 life insurance plan. He told me that it would be insured by the Federal Deposit Insurance Corp. and that I can take the money out any time. I could not find any information about this account on the FDIC website. Is this an insurance product or a savings account? Is it for me?

Thank you,

- Danny Doubts

Dear Danny,

I'm wondering if your neighbor is trying to sell you something. But let's talk about this unique kind of product.

The number refers to the 7702 section of the U.S. tax code, defining a kind of life insurance contract. When we refer to 401(k) plans, 403(b) plans or 529 plans, the names reflect the section of tax code describing these types of accounts.

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A life insurance contract is different in a number of ways from a bank account. For example, it isn't covered by FDIC insurance as a savings account would be. Life insurance contracts are backed by insurance companies issuing policies. In the unlikely event the company fails, it is backed by a pool of funds collected from the insurance firms and managed by the state department of insurance. There are limits on the amount of coverage per policy. The National Organization of Life and Health Insurance Guaranty Associations provides a listing of the limits organized by state and policy type.

Life policies that have a savings component allow you to borrow against the cash value of the policy. The money also grows tax-deferred in the account over time. Should you invest in such a policy? I don't know enough about your financial situation or the policy itself to make a recommendation. So, I'm cautious. Unless your neighbor is also your financial adviser, he shouldn't be giving you any advice about your own particular situation.

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