Life Insurance Retirement Plan (or LIRP) is a tax-efficient way for individuals to save for retirement by providing benefits you can enjoy during your lifetime.
It will also pay a tax-free death benefit to help replace your lost earnings potential.
Life Insurance Retirement Plan allows you to protect your loved ones while saving for retirement. LIRP is a perfect supplemental retirement strategy for high-income earners who are maximizing qualified plan contributions.
Using the Right Mix
When we think about retirement, most people visualize a 401(k) or IRA. We call these qualified assets. Qualified plans/assets are great tools for saving for retirement. They offer tax-deductible contributions and tax-deferred growth – a win-win.
The problem with qualified assets is they are taxed at ordinary income tax rates when you take distributions from them. And, in most cases, if you can’t access them until you’re 59 ½ without penalty.
This is why it is important to diversify the tax structure of your retirement assets. Instead of investment diversification, we’re talking about tax diversification. Doing this will provide greater flexibility during retirement.
To begin, start by looking at how your retirement assets will be taxed. The following represents the different asset classes and assets that make up those classes. Think of each class as a bucket – retirement buckets.
Assets Held Insider Retirement Plans
Distributions are generally taxed at ordinary income rates. They include:
- 401(k)
- Pension Plans
- Traditional IRA
Assets Held Outside Retirement Plans
Generally taxed at capital gains tax rate. They include:
- Stocks
- Mutual Funds
- Real Estate
Overlooked Assets
Generally Tax-Free. They include:
- Life Insurance Retirement Plan
- Roth IRA Distributions
- Municipal Bond Interest
Having assets in each class allows you to pick and choose what asset class to draw from during retirement. Being less reliant on accessing taxable distributions from an IRA gives you control over maximizing your retirement income.
How Does a Life Insurance Retirement Plan (LIRP) Work?
A Life Insurance Retirement Plan can provide tax-free distributions through policy withdrawals and loans and a tax-free death benefit.
Step #1
Purchase a personally owned cash value life insurance policy. The types of cash value life insurance policies most commonly used are whole life, variable life, and indexed life. In most cases, we recommend an indexed universal life insurance policy.
Step #2
The growth of the policy’s cash value is tax-deferred (just like a 401(k) or IRA).
Step #3
At retirement, you can take tax-free withdrawals and loans from the policy’s cash value to supplement your retirement income.
Step #4
At your death, your beneficiary will receive the policy’s death benefit tax-free.
When taking advantage of LIRP there are endless policies to choose from. As mentioned previously, the most common policies are whole life insurance and indexed universal life insurance.
Most life insurance companies held as stock companies offer indexed universal life insurance. A stock insurance company is a publicly traded company listed on a stock exchange. These companies include Prudential, Lincoln National, MetLife, and many others.
Insurance companies held as mutual companies tend to offer whole life insurance. A mutual insurance company is a company owned exclusively by policyholders. These include companies like MassMutual, New York Life, and Northwestern Mutual.
Learn More About Stock vs. Mutual Insurance Companies
Discover if a Life Insurance Retirement Plan would benefit you. Schedule a complimentary 20-minute consultation to learn more.
Life Insurance Retirement Plan (LIRP) Example
When considering a life insurance retirement plan there are a couple of key considerations:
- The policy should be designed for accumulation, not death benefit (we’ll cover this more below).
- You may need to purchase additional coverage separate from LIRP to satisfy YOUR NEED for insurance.
- Understand how the performance of the policy works (cash value growth), and how distributions in the form of withdrawals and loans will impact the policy.
For purposes of this example, we will use the following assumptions:
- Age 45 Male in Good Health
- Interested in funding the policy each year until projected retirement at Age 65
- Distributions from the policy will start at Age 70 and will continue for 20-years
- Interested in funding the policy at $12,000 per year
We will use an indexed universal life insurance policy. Learn more about indexed universal life insurance and how it works.
When evaluating a life insurance retirement plan policy, it is important it is designed properly.
To maximize cash flow for retirement the policy should have as little death benefit as possible. When doing this the death benefit will vary from year-to-year. This amount will also vary from carrier to carrier and will be impacted by the different assumptions used when designing the policy.
By minimizing the death benefit, we are also minimizing the cost of the insurance in order to maximize the policy’s cash value.
When using a life insurance retirement plan your outlook should be at least 10-years, if not more. The longer the outlook the more beneficial it will be. Do not consider a LIRP if you need immediate access to the money or are unsure if you will be able to continue to make ongoing premium payments.
For purposes of the life insurance retirement plan policy being illustrated we have assumed the following:
S&P 500 Capped Account Rate
This is the underlying index used to determine how the policy is credited on annual basis. The index is capped at a maximum crediting rate of 6.39%, and is calculated on an annual point-to-point basis. The smallest amount the policy can be credited is zero percent.
Let me explain this in non-insurance language.
If the S&P 500 is at 1,000 today and a year from now it grows to 1,100 – the S&P 500 would have grown by 10-percent. But since the policy’s maximum crediting rate is 6.39%, this is the maximum amount the policy cash value will be credited.
Conversely, if the S&P 500 is 1,000 today and drops to 900 a year from now (-10%) your policy cash value will be credited a minimum of zero percent. This occurs in all years the S&P500 performs negatively.
Please note in an indexed universal life insurance policy you are not actually invested in the actual index. This is why the return is capped and losses are minimized.
Learn more about how indexed universal life insurance works.
Cash Value Enhancement Rider
In most situations, we like to use a Cash Value Enhancement Rider (CVER) for life insurance retirement plans. By doing this the policy cash value is higher in the earlier years than it would be without this rider.
It will typically have a minimal effect on the cash flow during retirement, but will normally reduce it slightly.
The benefit of having this rider is if you need to cash out the policy in the early years you will receive most of what you’ve paid into the policy back.
Standard Loan
What makes all cash value life insurance policies unique is how distributions from policies are generally tax-free. This is accomplished using two methods.
- Withdrawal of Principal. Individuals are never taxed on principal (or cost basis). It’s simply a return of getting back what you put in.
- Any cash flow received above the principal amount is treated as a loan from the policy to the policy owner. Loans are never taxable to the recipient. The loan is then repaid at the death of the
insured by the death benefit. A policy death benefit is generally income tax-free.
Understanding how a loan from a life insurance policy is an entirely different post. We will do our best to create one soon.
For it to be a legitimate loan there must be loan interest. With an indexed universal life insurance policy the loan interest is commonly calculated using one of two options – a standard or variable (index) loan rate.
We ALWAYS use the standard loan option. The standard loan options is generally between 0 – 1.5% net interest cost. An index loan could be as high as 6 to 8% depending on the policy.
Overloan Protection Rider
The Overloan Protection Rider (OPR) creates a paid up policy in situations where money has been borrowed from the policy. It essentially freezes the policy to prevent additional charges from being incurred so the policy doesn’t lapse.
The reason we add this is to make sure the policy does not lapse after loans have been taken from the policy. If the policy were to lapse all of the loans take would be treated as ordinary income. By including the OPR we avoid taxation on the loan and provide the beneficiaries with a minimal death benefit net of the loan balance.
Life Insurance Retirement Plan (LIRP) Case Study
This is a hypothetical illustration. Each individual scenario should be illustrated according to your specific needs and requirements.
Getting back to our earlier example, the following illustrates a Life Insurance Retirement Plan policy on our previously mentioned 45-year old male. We will illustrate this in two phases: the Funding Period and Accumulation and Distribution Period.
FUNDING PERIOD – YEARS 1 THRU 20
During the funding period, we assume a planned yearly premium payment of $12,000. Based on the planned premium payment and current assumptions the initial death benefit is $262,321. This is the minimum death benefit available without making future distributions from the policy taxable. Based on current assumptions the death benefit will grow to $634,435 over the 20-year funding period.
ACCUMULATION AND DISTRIBUTION PERIOD – YEARS 21 THRU 50
Following the Funding Period, the policy owner begins the Accumulation and Distribution Period. Beginning in Policy Year 25 it is projected the policy will distribute $47,776 per year TAX-FREE for 20-years. This turns out to be just less than $1 million of projected tax-free distributions.
During this time, the death benefit will begin to decline. The death benefit column is the amount of projected death benefit proceeds your beneficiary would receive in any given year. The death benefit is illustrated net of any loans. Because of this, loans made from the policy will continue to be tax-free as long as the policy remains in force until the insureds death.
The Case for Life Insurance Retirement Plan (LIRP)
LIRP is not for everyone. It is for high-income earners maximizing retirement contributions looking for additional tax-efficient ways to improve their retirement income and savings. The tax benefits available through life insurance provide a unique way to accumulate supplemental retirement income with a tax-free death benefit.
Each individual situation is different. When considering a life insurance retirement plan is important to see how it compares to the other asset classes. Depending on the carrier and product type outcomes can vary significantly.
The information contained in this article is hypothetical. Results and performance will vary based on a number of factors. If you are interested in a Life Insurance Retirement Plan you should consult with a licensed advisor to help you understand and evaluate your options.
