Similar to a Roth IRA or 401k, a Life Insurance Retirement Plan (LIRP) is a financial plan based on paying more money in your life insurance policy than annually required (you can use whole life, variable universal life, current assumption universal life, and indexed universal life insurance) — to save money for retirement.
Unlike the Roth IRA and 401k, the LIRP is famous for being the one that you will pay THE LEAST amount of taxes for.
Before going into detail about LIRP, let’s cut to the chase with some simple facts that many people reading this article are looking for:
- YES: When you retire, you CAN take tax-free distributions from your accumulated cash value in the form of policy loans with LIRP.
- YES: it is also possible to take tax-free distributions from your Roth IRA, but Roth IRA doesn’t offer death benefit protection and has limits on how much you can put in it each year.
- HOLD ON: Even though your 401k contributions are tax-deductible, the fact is that the income you take from your 401k or IRA is fully taxable.
Not to mention the fact that if you take any money out before you are “59 and a half” you have to pay a 10% early withdrawal penalty ON TOP of the taxes you pay for your 401k income.
- NO: you will not receive a tax deduction when you contribute to a LIRP, but! — you will be able to take tax-free income FROM your LIRP.
Because a LIRP can save much more money in the long run with a clever strategy, many people opt for a Life Insurance Retirement Plan as their go-to financial plan.
With that said, now it’s time to go over exactly who the LIRP is best suited for, and precisely how you can benefit from it.
How Does Life Insurance Retirement Plan Work?
Life Insurance Retirement Plan is a financial planning tool most often used for avoiding large taxes to achieve personal financial goals for retirement.
However, it’s not that simple, and you probably wouldn’t be reading this if it was.
The most used life insurance product for a LIRP is indexed universal life (IUL) insurance. When they’re structured properly, LIRPs will provide the tax-free advantages of a Roth IRA without the contribution limits of a Roth IRA.
It will minimize your expenses and maximize cash value, creating as much tax-free income as possible — that is the main benefit.
It should be emphasized that a LIRP HAS TO be structured properly for the insurer to enjoy maximum cash accumulation growth and tax-free income at retirement.
Since a LIRP is a life insurance policy there definitely are expenses to consider, and strategies to keep your LIRP IRS compliant as well as income tax-free.
It’s not a bad idea to try to compare a LIRP to your current IRA or 401k so you can understand how they work more easily.
Pros And Cons Of A Life Insurance Retirement Plan
A Life Insurance Retirement Plan (LIRP) is really simple in theory. LIRPs can best be described as “over-funded policies” — the amounts above the premiums required to keep the policy in force are paid annually. The goal here is to maximize the cash value by paying more than your annuities require.
A LIRP accumulates interest each year, and your account value grows.
You fund the universal or whole life insurance policy and can then borrow against the accumulating cash value by way of a loan completely tax-free.
There are a lot of benefits to including a LIRP in your retirement planning. Tax-deferred accumulation, asset protection, and penalty and tax-free distributions to name a few.
Let’s look at the main benefits, as well as some drawbacks when investing in a LIRP.
The Pros
- They’re Safe
Unlike the millions of Americans that lost a fortune of their hard-earned savings when the stock market crashed in 2008, people who use LIRP’s are protected from these kinds of events.
- Guaranteed Death Benefit
The life insurance death benefit is paid to your beneficiaries income-tax-free.
And the death benefit on a life insurance retirement plan can be designed to increase each year as your cash value grows, so when you do die, your beneficiary receives the maximum death benefit possible.
- Flexibility
If you have a slow month and can’t make a payment, that’s okay — with a LIRP you can pay less that month.
If you have a huge emergency and can’t pay your loan payment this month, that’s okay as well. You will never have any penalties for late payments on loans.
- Retirement Income During Life and Replacement Income Upon Death
In life, your LIRP can be used as tax-free income via withdrawals up to your basis or you can borrow against your cash value. Having a steady stream of tax-free income from your policy is a great way to boost your retirement income.
the LIRP provides income protection in the event that you can no longer provide that retirement income for your loved ones. A LIRP provides a tax-free death benefit to your beneficiaries upon your death.
- Long Term Care
If you choose disability features inside a LIRP, you can provide for your spouse and family if you are permanently disabled, if you need long-term care, or if you are terminally ill — with long-term care and chronic illness riders.
Also, if you are unable to perform 2 or more activities of daily living, a long-term care rider can protect you.
A chronic illness rider provides protection if you are diagnosed with a qualifying chronic illness, and you can even add additional long-term care riders or chronic illness riders for more protection.
This peace of mind that comes from a LIRP is the reason why LIRPs are sometimes considered as retirement plans that are “self-completing”.
- Hedge Against Rising Tax Rates
Most retirement strategies are either fully taxed, or tax-deferred — you either pay full taxes every year on the gains from your investments — or you defer taxes on your gains and pay them when you withdraw your funds (tax-deferred).
The LIRP on the other hand is absolutely tax-free.
- You Essentially Pay 0% Interest When You Borrow
Even though you DO pay interest when you borrow from your LIRP, because you also RECEIVE interest from your LIRP, the loan typically ends up being a 0% wash loan: meaning, you earn what you pay, which makes it “a wash loan”.
- It’s Infinite-Baking-Friendly
Have you heard about Infinite Banking?
In short, it’s borrowing from your policy and paying yourself back interest — which essentially transforms your policy into a bank.
People who practice Infinite Banking usually choose to pay themselves back at higher rates, because they want to accelerate their money growth — and YOU can achieve it too.
You can use your LIRP to own your own lifestyle, become your own bank, and even lend money to others (for example, friends and relatives at an extremely good rate with flexible terms — but you still profit in the long term).
- No Funding Limit
There are no limits on how much you can place into a LIRP and there is no income threshold prohibiting you from funding a LIRP, like in a Roth IRA.
- Different Insurance Options for Different Objectives
A LIRP can be created using any number of life insurance companies and policies.
You can choose between a participating whole life, universal life, indexed universal life, and variable universal life type of insurance.
Each type of life insurance coverage has its pros and cons associated with it — so make sure to do further research yourself, depending on your goals.
(For example, in comparing whole life vs universal life, participating whole life is going to be a safer, more conservative option than variable universal life.)
However, some people may choose an IUL despite the 0% loss protection — because of the potential for higher gains than whole life insurance.
The Cons
There are some major criticisms for LIRPs — since no financial plan can work for all future retirees. Here goes:
- LIRP’s Can Be Too Expensive
Yes, Life Insurance Retirement Plan can get expensive in the beginning when paying your premiums.
Many financial advisors that are critical of permanent life insurance like to compare term and whole life insurance. But…
“They will compare a 35-year-old male non-smoker with good health paying for $1 million dollars of insurance. The premiums are just over $1,400 for 20-year term insurance, and almost 10x that amount of whole life insurance.
But this comparison is not fair for a couple of reasons.
First, the comparison chooses the cheapest term insurance to the most expensive permanent insurance.
If the term was 30 years, the rates would be almost double, and if you choose a different kind of permanent insurance the rates would likely be closer to 5x or 7x that of term insurance. But that’s still a big difference!
True, but that brings us to the second reason this comparison is not fair.
In the example of the term premium, the premium is only paying for insurance, while with the whole life premium, a portion of the premium is going to cash value.
Further, the term may be less pricey early on, but consider what the term life premiums will be in 10, 20, or 30 years.
Now you want to renew your policy only to find out that your term life insurance premiums are what your cash value life insurance premiums were back when you chose the term vs permanent policy.
You could have locked into a policy that lasts your entire life and that builds cash value that you can access tax-free in retirement for the same price you will be renewing that term life policy for.”
Source
- They can become a MEC
If you contribute too much your policy could become a modified endowment contract or a MEC. MECs are life insurance policies with too little death benefit to support the premiums being paid.
If a policy is found to be a MEC by the IRS, the policy will not fall under the favorable income tax treatment of the LIRP because the IRS will deem it as too “cash-value-rich”.
That ties in with the aforementioned “strategies to keep your LIRP IRS compliant” and income tax-free, so that you can keep more of your retirement savings.
What’s important here is that you’re aware of this before going to your financial advisor — it will save you both your time and effort.
- They’re Slow Growing and Often Come With Low Interest Rates
“It’s easy to listen to someone saying that a LIRP will only get a 5% interest rate annually, and think that you’ll never be able to retire. And at the same time, the financial planner that is critical of a LIRP is likely to show mutual fund rates of returns that are almost double that of a LIRP.
However, five consecutive years of 10% returns can be easily wiped out by one -40% return. And to make matters worse, you have now lost 6 years.
If you compare two initial investments of $100,000 over the course of 20 years, one of which earns 5% annually every year, and the other that earns 10% annually, you get an obvious result. Everybody wants the 10% return.
However, if your 10% return investment column has just one bad year in which you take a 50% loss, you come out about even in year 20. And if you have more than one year that is bad, you will come out ahead with the 5% return.”
Source
So… Is Life Insurance Retirement Plan For You?
Well, it depends. Most of the time, the following types of policyholders can reap MAJOR benefits from a LIRP like in no other type of retirement plan:
- High-income earners who are already contributing to IRAs and 401(k)s, and are now looking for additional avenues with which to save for retirement.
- Families with special needs children who need constant care — because the death benefit provides all the funds necessary to support the children upon the death of the insured.
- High net-worth individuals with upcoming estate tax issues can absolutely benefit from the tax advantages that come with a LIRP — because the death benefit from the policy can be used to pay these taxes.
If you don’t fit into any of these categories — don’t get discouraged.
Set up a meeting with your financial advisor and see what you can gain from a LIRP — they are on the rise and more popular each day, so new strategies are sprouting, even if you don’t fit in any of these groups.
Summary
These are the things you should know before contacting any life insurance agents:
The LIRP is a tried and tested financial strategy for retirement and healthy financial living that has been around for decades.
However, this technique is definitely not for everyone, and can not replace your 401(k)s and IRAs entirely.
The main benefits you can gain from LIRP’s are tax-free distributions, tax-free death benefit, a guaranteed interest rate (hole life policies only), growth potential (Universal, Indexed, and Variable policies), Accelerated benefit riders, Provisions for estate taxes, and provisions for special needs children — to name the biggest ones.
You should also keep in mind that LIRPS also come with nondeductible contributions, cost a lot more, and may come with lower interest rates — which means they might not be the best option for you.
It’s important to remember that a LIRP is a good, but not a one-size-fits-all solution for your retirement income.
On the other hand, a LIRP is applicable to different individual situations, so take your time to find the right financial advisor for YOU.
Focus on your primary goal and if the LIRP offers a benefit that is of great importance to you — stick to it and look for a financial planner that can make it work for you.
Look for an agent that emphasizes looking out for the policyholder — and has the results to back it up. Be on your guard, take your time, pick wisely, and good luck!