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Life Insurance Retirement Plans (LIRPs)

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    Article Highlights

    Although most financial planners will tell you that stocks and stock mutual funds are the way to go when it comes to retirement planning, some investors will look for alternatives in order to be more broadly diversified. A life insurance retirement plan (LIRP) can serve as an effective alternative or supplement to traditional forms of retirement savings, such as through an IRA or employer-sponsored retirement plan.

    This type of plan is free from many of the restrictions that are associated with IRAs and qualified plans. Although a LIRP is not designed to replace traditional avenues of saving for retirement, it can provide substantial benefits for certain people, depending on their circumstances.

    What is a life insurance retirement plan?

    In a nutshell, a LIRP is simply a cash value life insurance policy that is overfunded over time, in order to build up a larger amount of cash value by the time you retire. You can use any type of cash value policy to do this, but some types of coverage will accumulate faster than others — with some potential risk involved. LIRPs are designed to provide retirement savers with a supplemental source of income in addition to their IRA and retirement plan distributions during retirement.

    Although LIRPs do not have all of the same tax advantages that IRAs and qualified plans can provide, they do have additional benefits that IRAs and qualified plans cannot match. For example, there is no age requirement for distributions (in the form of tax-free loans) from a LIRP, and LIRPs can often provide guaranteed principal and interest — unless the investor is using a variable universal life insurance policy. But most LIRPs today are funded with either whole life, universal life or indexed universal life policies that at least guarantee the amount of principal that is invested in them, if not the exact rate of return that they will earn.

    What is the cash value of a LIRP?

    The cash value is the savings component that comes with all cash value life insurance policies (hence their name). The cash value earns interest at either a guaranteed or variable rate. With whole life policies, the rate is guaranteed. With universal life policies, the rate is variable and fluctuates in tandem with the prevailing interest rate environment. With indexed universal life policies, the rate is linked to the performance of an underlying financial benchmark index such as the S&P 500 Index. The interest paid in a variable universal policy is based upon the performance of the mutual fund sub-accounts inside the policy.

    Who needs a life insurance retirement plan?

    In most cases, there are three basic scenarios where a LIRP can provide the most benefits for retirement savers:

    • High-income earners who are maximizing their traditional retirement savings vehicles such as IRAs and 401(k)s and need additional avenues with which to save for retirement.
    • Families with special needs children who must always be cared for. In this scenario, the death benefit will provide the funds necessary to support the children upon the death of the insured.
    • High net-worth individuals who will have estate tax issues may also find the tax advantages that come with a LIRP appealing.

    How can you use a LIRP to fund retirement?

    Using a life insurance retirement plan is a fairly simple process: just overfund the policy during your saving years and let the cash value in the policy grow. Then take out distributions from the policy in the form of tax-free loans during retirement. When you die, your beneficiaries will receive the full death benefit minus the amount that you withdrew while you were retired.

    How much does it cost to invest in a LIRP?

    There is no set amount that you have to invest, other than the minimum amount that must be paid in order to keep the policy in force. But the whole concept of a LIRP is to overfund the policy so that the cash value builds up over time. For example, if you buy an indexed universal life insurance policy with a $1 million death benefit and the monthly premium is $894, then you could perhaps pay $1,500 per month into the policy so that the excess amount is stored up in the cash value.

    LIRP versus 401(k)s and IRAs

    Both LIRPs and IRAs and 401(k) offer tax advantages, but the tax advantages with LIRPs differ from those of the other two savings vehicles. Here’s a breakdown of the pros and cons of investing in a LIRP versus either of the other two alternatives:

    IRAs allow for deductible contributions and access to almost any type of investment. But all distributions are taxed as ordinary income unless it is a Roth IRA. LIRP contributions are always non-deductible and they have very few investment alternatives. But they can pay a guaranteed rate of interest and withdrawals are tax-free. You can also withdraw money from an LIRP before age 59 ½ without penalty.

    401(k)s allow for pre-tax contributions and may also have matching employer contributions. All distributions are taxed as ordinary income unless the plan is a Roth plan. LIRPs have no matching contributions but offer tax-free withdrawals.

    Why invest in a LIRP?

    If you are someone who wants more control over your retirement savings, an LIRP may give you greater freedom and flexibility than you might get with IRAs and qualified plans. LIRPs have no minimum age requirements for distributions and also provide a tax-free death benefit if you die before you retire (and after you retire as well). 

    In addition, most cash value policies today also offer accelerated death benefit riders. These riders can pay out if you need to pay for long-term care expenses or are diagnosed with a critical illness such as cancer. IRAs and qualified plans have no provision for this, except that you might be able to access your money without penalty if you become incapacitated.

    Pros and Cons

    Here are a few key considerations surrounding LIRPS:

    Tax-free distributionsNontaxable contributions
    Tax-free death benefitHigher cost
    Guaranteed interest rate(Whole life policies only)Interest rate may be low
    Growth potential (Universal, Indexed and Variable policiesLimited investment choices
    Accelerated benefit ridersMay never be needed
    Provisions for special needs children, estate taxesAdditional cost

    The Takeaway

    • LIRPs can be used as a supporting savings vehicle for retirement.
    • LIRP death benefit protection and accelerated benefit riders cannot be matched by IRAs and/or qualified plans.
    • LIRPs are not necessarily the best option for everyone, but can be more flexible and versatile than traditional methods of retirement savings

    Life insurance retirement plans definitely have their niche in the world of retirement planning, but middle and lower-class savers may benefit more from IRAs and employer-sponsored retirement plans for their savings. But LIRPs can be invaluable to those with special needs children or high income or net worth savers for a variety of reasons. Consult your financial advisor for more information about LIRPs and whether one could be right for you.

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