LIFE INSURANCE RETIREMENT PLAN LIRP: How It Works

If you’re approaching retirement age, you may be wondering how to maximize your golden years. A life insurance retirement plan is one option to explore. This plan allows you to use the proceeds of your life insurance policy to fund your retirement lifestyle. A universal life or whole life insurance policy can be used to supplement your retirement income, but there are various dangers associated. Find out how a life insurance retirement plan (LIRP) compares to a 401(k) and an IRA. Here’s an example of how it works.

What is a Life Insurance Retirement Plan (LIRP)?

A Life Insurance Retirement Plan (LIRP) is a specific life insurance approach that maximizes tax-deferred retirement savings while safeguarding your beneficiaries. These plans are created utilizing permanent life insurance products, with premiums paid each year contributing to two important components: a Life Insurance Death Benefit and a Cash Value savings vehicle.

Life Insurance Death Benefit

A perpetual life insurance policy is used in the construction of a LIRP, and if the insured dies, the beneficiary receives a tax-free death payment. Life insurance coverage can be established in a variety of ways, including a flat death benefit (constant throughout the policy) or an increasing death benefit.

These policies are deemed overfunded, which means that after a portion of the premium is used to meet the insurance expenses of the death benefit, the remainder goes into a cash value savings account. The policyholder can use the cash value savings account, as explained below, to provide eventual retirement income.

Cash Value

A savings account known as cash value under the life insurance policy grows tax-free and can be invested in mutual funds, indexes, or fixed-income assets. Tax-favored loans and withdrawals, when properly arranged, can be used to obtain the cash value at a later date, generating a stream of cash flow to be used as retirement income.

LIRPs are similar to Roth IRAs in that they are funded with after-tax monies and earnings and payouts are tax-free. However, with a LIRP, the investor pays for life insurance coverage, and it is important for them to have life insurance in order to construct a plan. LIRPs are a popular alternative for many high-income workers who have been phased out of Roth IRAs due to income constraints.

How May a LIRP be Used to Fund Retirement?

LIRPs can supplement your existing retirement plans and fill up the gaps if the stock market falls. If you contribute the maximum amount to your standard investment accounts, you can put any excess funds into your cash value account, giving an additional route for tax-deferred investment development. In a weak year for the stock market, it may be more advantageous to withdraw from a cash value with a guaranteed rate of growth rather than a retirement account with a depreciated value.

#1. Pay a more premium than is required to fund your cash value.

Some policyholders seek to overfund their cash-value life insurance policies by paying far more than the statutory premium each month in order to accumulate enough cash value to supplement retirement. The extra money customers pay goes towards the cash value of the policy and increases tax-free. However, this technique only works provided you don’t need to make withdrawals before the age of 591: An overfunded cash value policy that exceeds the annual premium maximum (established by the IRS) changes into a modified endowment contract (MEC) and is liable to additional taxes and penalties for withdrawals.

#2. Use the cash value to boost your retirement income.

Many financial professionals advocate the “4% rule,” which states that you should withdraw no more than 4% of your retirement funds each year. When you own a cash-value life insurance policy, you will have access to the cash value of your policy as well as your retirement savings.

This enables you to plan ahead of time for your retirement spending. For example, if the stock market has a bad year, you can withdraw money from your policy’s cash value rather than your IRA, which will refill your IRA savings.

#3. Long-term care assistance

A long-term care rider can be added to most life insurance plans, including cash-value policies. If you need to pay for a nursing home or other medical bills connected with aging, this rider gives an expedited death benefit.

Who Might Benefit From a Life Insurance Retirement Plan?

The majority of the time, a LIRP is appropriate for retirement savers in three situations:

  1. High-income earners are contributing as much as feasible to traditional retirement savings vehicles such as IRAs and 401(k)s and are seeking new ways to save for retirement.
  2. Families with special needs children must be cared for at all times. In this case, the death benefit will give the monies required to support the insured’s children following the insured’s death.
  3. Individuals with high financial goals for retirement may find that branching into LIRPs on top of regular retirement savings plans is an effective method to establish a broader retirement savings foundation. The IRS does not set a maximum contribution level for LIRPs because they use life insurance as an investment vehicle.

What is the Cost of Investing in a Life Insurance Retirement Plan LIRP?

The premiums for your permanent life insurance policy are invested in your LIRP, and you can opt to add extra cash to that amount. Permanent life insurance is more expensive than term life insurance; whole life insurance premiums are 5 to 15 times more on average. If cost is your goal, purchasing a term policy and investing the savings from not purchasing a whole-life policy makes more sense than funding a LIRP.

Cost comparison, term life insurance, and traditional investment against LIRP

Term & 401(k)Term & Roth IRAPermanent & LIRP
Monthly premiums$25.18$25.18$481.00
Cost of retirement accountNo minimum investment requiredNo minimum investment is required, some brokers set a minimum initial investmentCost of policy premiums
Maximum investment per year$20,500 (+$6,500 if older than 50)$6,000 (below age 50); $7,000 (age 50 & up)N/A

401(k)s and IRAs vs. Life Insurance Retirement Plans

Regardless of the type of life insurance policy you choose, designated retirement funds such as a 401(k) or an IRA should remain the primary way you fund your retirement. When compared to specific retirement investing options, cash value life insurance has fewer investment options and lower rates of return.

A 401(k) is a retirement savings plan provided by employers to their employees. Many firms additionally match a percentage of their workers’ 401(k) contributions.

An IRA is an individual retirement plan that you form and fund on your own. IRAs can be utilized alone or in conjunction with an employer-sponsored 401(k).

LIRPs, standard 401(k)s, and Roth IRAs are all taxed differently.

Policy specifics

LIRP (cash value life insurance) (cash value life insurance)

Traditional 401(k) plan (k)

IRA Roth

Contribution caps

Depending on the insurance

$20,500 (+$6,500 if over 50)

$6,000 ($7,000 if over 50)

What you can do

Premiums (after-tax dollars) (after-tax dollars)

Pre-tax earnings

After-tax dollars with no tax breaks

How does your money grow?

Tax-deferred

Tax-deferred

Tax-free

Qualifications for (penalty-free) withdrawal

5912 years of age or older, and at least 15 years of account history

5912 years and older

5912 years of age or older, and a five-year account

Taxes on withdrawals

Only if the amount of your withdrawal exceeds the cash value base amount.

Regular income is taxed.

There are no income taxes.

Minimum distributions required

Variable depending on policy premiums

7012 years and older

None

Capital gains taxation

Yes

Yes

No

What are the Best Life Insurance Retirement Plan LIRP To Use?

The ideal LIRP insurance will be determined by your circumstances, goals, timeline, and provider. Some types of permanent life insurance provide a larger potential for profit but fewer loss safeguards. Other varieties may provide greater protection but have lower upside potential. In general, universal life insurance policies provide fewer safeguards and higher gains potential, whereas whole life insurance policies provide the contrary. Discuss your objectives with a professional financial planner or your insurance agent to identify the best path for you.

How Long Have LIRPs Been In Existence?

LIRPs emerged from cash-value life insurance policies and have been utilized since these insurance plans were first commercially offered. More cash-value policy types have been developed as the life insurance market has evolved and expanded. The use of LIRPs has grown in popularity with the introduction of some of these newer types of permanent life insurance. This is due, in part, to the fact that some of these newer forms allow for faster monetary value buildup in the correct circumstances.

The Benefits and Drawbacks of Life Insurance Retirement Plan

A life insurance retirement plan can provide additional flexibility in some situations, but there are several reasons why depending on cash value life insurance for retirement isn’t recommended for most people.

Pros of LIRPsCons of LIRPs
Guaranteed death benefit when you dieExpensive premiums can be difficult to maintain long-term
Penalty-free access to cash value (if borrowing and not withdrawing)Additional fees for withdrawals depending on how long you’ve held the policy
No contribution limitsLower investment returns than a 401(k) or IRA
Tax-deferred cash valueCash value loans accrue interest until repayment (the loan plus interest is deducted from your death benefit when you die)
Guaranteed minimumContributions are not tax-deductible

Is Whole Life Insurance a Suitable Retirement Investment?

Most people should avoid LIRPs, but there is no one-size-fits-all approach to retirement savings. For most people, the high cost of permanent policies (such as whole life insurance) — over half of which are relinquished within 10 years for this reason — and the lower rates of return outweigh the benefits of having a supplementary retirement account. [2]

If you make the maximum annual contribution to your retirement account and do not wish to put additional cash into a regular post-tax investment account, a LIRP may be worth considering. Purchasing a term life policy and keeping a 401(k) or Roth IRA is the greatest alternative to a LIRP. Even if you routinely max out your retirement accounts, a conventional post-tax investing account can provide a higher return on your contributions. When you no longer require life insurance, it is easier to terminate term coverage than it is to cancel a permanent policy.

What Happens to My Money if I Decide to Terminate My LIRP?

There are two approaches to terminating your permanent life insurance policy, each with different outcomes. The most straightforward way is to surrender your policy to the insurer. This approach yields the cash value of your policy, minus any fees. The other alternative is to put your policy up for sale on the market. If successful, the buyer will receive complete ownership of the policy for whatever sum is agreed upon. If you choose this route, some insurers may assist you in selling your policy, although this is not always the case. You lose access to the policy and any benefits or payouts in both situations. To learn more about your options, speak with a certified financial planner or insurance agent.

Conclusion

Most people should avoid LIRPs, but there is no “one-size-fits-all” strategy for retirement investing. For most people, the high cost of permanent insurance and lower rates of return outweigh the advantages of having an additional retirement account.

If you wish to contribute the maximum amount to your retirement account each year but cannot put any more money into a traditional post-tax investing account, a LIRP may be a smart solution.

Purchasing a term life insurance policy and funding a Roth IRA or nonqualified annuity is the greatest option for a LIRP. With a Roth IRA annuity, your retirement income can still be tax-free and last your entire life. Additionally, only interest earned is taxed in a nonqualified annuity, providing you with an income for life and a huge tax reduction over the long term.

Life Insurance Retirement Plan FAQs

Which retirement provider is best?

  • Best Overall: Fidelity Investments.
  • Best for the Self-Employed: Charles Schwab.
  • Best for Low Cost: Vanguard.
  • Best Robo-Advisor: Betterment.

IRAs. One of the most common retirement plans is the IRA. An individual can open an IRA at a financial institution such as a bank or brokerage business to hold retirement investments such as stocks, mutual funds, bonds, and cash.

What is a good monthly retirement income?

A healthy retirement income is approximately 80% of your pre-retirement income before you leave employment. For example, if your pre-retirement salary is $5,000, you should aim for a retirement income of $4,000 per year.

References

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