What is a Life Insurance Retirement Plan (LIRP)?
A Life Insurance Retirement Plan or LIRP is more than just a policy that provides a death benefit to the beneficiaries, it’s a unique, “triple-threat” retirement strategy that blends in guarantees, tax efficiencies, and downside market protection.
It’s very similar to a Roth IRA; however, you don’t have all the disadvantages like income restrictions, low funding limits, and negative market corrections.
While selecting a retirement planning strategy, there are various factors you need to keep in mind. Some of the important ones are – security of your money, taxation, penalties, funding limits, creditor protection, and flexibility.
When saving for retirement, your plan needs to ensure that it offers the features that are most ideal for you, your tax situation, and your risk tolerance. For most risk-averse clients, the security and taxation of the plan matter the most. This is why life insurance retirement plans are such an attractive option for many people who are saving for the future.
When it comes to tax, the policy falls into the tax-advantaged category. Like a Roth IRA, LIRP’s are funded with after-tax dollars, so the account grows tax-free and you can take the money out tax-free utilizing a borrowing strategy. You can actually take the money out via a simple withdrawal, but based on what you are trying to accomplish, requesting a loan out of the policy may be a better option.
Due to the rising federal deficit and the current low tax environment that we all are enjoying, many soon-to-be Bedford retirees are warming up to the idea of adding a LIRP as part of their retirement planning.
Under a taxable account (like a brokerage or mutual fund account), the owner pays taxes every year on the gains. In a tax-deferred strategy, the owner pays the tax at the time of withdrawal (which may be considerably higher than it was during their working years). When it comes to life insurance retirement plans, the income that is distributed is tax-free.
For those who value safety, the LIRP offers superior security of your retirement savings, as the returns are guaranteed, via either a predetermined dividend rate, an index crediting rate, or a guaranteed minimum rate. For reference, with a properly designed LIRP, you can expect an after-tax rate of return of anywhere from 5-7% on your contributions over time.
That said, the Life Insurance Retirement Plan (LIRP) has its own pros and cons.
Advantages of a LIRP
One of the major advantages of a LIRP is safety. It guarantees that your contributed amount will grow with a minimum interest rate each year, regardless of what the stock market does that year, and the guaranteed rate is typically four to five times higher than what you’d get at any bank. Additionally, the death benefit attached to the plan is also guaranteed. And, as with almost all traditional life insurance plans, (term, whole life, universal life) the death benefit will be provided to the beneficiary tax-free.
2. Protection against rising taxes
Another great thing about the LIRP is that it’s a fantastic option to hedge against rising taxes. Most of the traditional retirement strategies out there are tax-deferred, meaning you have no idea what the tax liability will be until you take the money out many years down the road. With life insurance retirement plans, it’s tax-free, which means even if taxes double in the future, you’re unaffected. That said, if you think your taxes will be just 1% higher in the future than they are today, you may want to consider adding a LIRP as part of your overall retirement planning strategy. Additionally, distributions you receive out of your LIRP do not cause taxation of your Social Security benefits like IRA/401k income does.
In most retirement strategies, you are charged a penalty on early withdrawals (e.g. a 10% penalty if you touch the money before 59 ½, a surrender charge if you access the money in the first ten years, etc.), but with a LIRP, you will not be penalized if you need to access the money before you get to full retirement age.
4. Long-term care protection
Life insurance retirement plans not only help your beneficiaries after your death, it will also help you during your retirement years if you have a long-term care or chronic illness event. Almost all of the companies out there offer a feature to where you can withdraw a portion of the death benefit today, while you’re still alive, in order to pay for long-term care, terminal illness, or chronic illness expenses.
The trade off? You just leave less death benefit behind after you pass away.
The benefit? You don’t have to deplete your current assets to pay for home health care, skilled nursing care, etc.
So, what’s the catch?
Well, as all things in life, nothing is perfect, and Life Insurance Retirement Plans are no exception. Here are some downsides to consider.
Disadvantages of a LIRP
1. Not everyone can get one
Since this is based on life insurance, you must be insurable. Meaning, if you have very poor health (cancer, heart issues, obesity) you may not qualify for one. Compared to other retirement strategies where your health status is insignificant (like 401k’s, IRA’s and annuities), this may become an obstacle to some. That’s not to say that you can’t get one if you have a few issues, but severe issues make it almost impossible to qualify.
2. It grows slowly in the beginning
One of the main reasons why many people don't like putting their money into LIRP’s is that they grow slowly in the beginning. Like the slow ramp-up of paying off a 15- or 30-year mortgage, early in the plan, you don’t typically see the explosion of cash growth that you experience once you’ve gotten past the first three to four years. Because of that, many people are hesitant to start one. However, these are not short-term strategies, they are meant for mid to long-term planning, so if you have the right mindset, this isn’t typically an issue.
3. Uncle Sam limits how much you can contribute
Though, the funding limits are quite high (some savers put $5,000/year, some put $500,000/year), they are capped by IRS limits. The way that is established is via the death benefit of the policy. Meaning, if you want to contribute a large amount, you must have a large enough death benefit on the policy to accommodate the contribution. When properly designed though, you’ll strategically set the death benefit to a level that lets you contribute the amount you want but doesn’t subject you to paying for any unnecessary life insurance you may not need. Only a qualified LIRP advisor can do this effectively.
4. Requires a disciplined, “savers” mentality
Due to the life insurance component of the plan, these plans are expected to be funded continuously, for at least five to seven years; however, longer is suggested. Because of that requirement, they really aren’t a good fit if you don’t have a steady cash flow.
Life insurance retirement plans do more than just provide a death benefit to the beneficiaries. As the name suggests, it works as both a life insurance policy and as a retirement plan.
Lastly, it’s important to note that you can’t use any type of life insurance for this strategy (like a term policy), and you should only implement one of these with the proper type of insurance and via a qualified advisor.
The tax-free structure, flexibility, safety, and legacy attributes make life insurance retirement plans one of the best, foundational pieces to a truly diversified retirement planning strategy.
If you’d like our help, or have any questions around LIRP’s, either join one of our webinars or reach out to us via our Contact form.