An life-insurance retirement plan (LIRP) can be a great complement to traditional retirement savings such as IRAs and company-sponsored retirement plans. This plan is not subject to the same distribution restrictions as qualified plans and IRAs. An LIRP cannot replace traditional ways of saving for retirement but it can offer substantial benefits if used properly.
Life Insurance Retirement Plans Explained
A life insurance retirement plan, also known as a cash value or permanent life insurance policy, is one that builds up substantial cash value over time. To do this, you can use any cash value policy. However, some types of coverage have grown more quickly than others in the past. The policyholder may have to take some market risk. LIRPs are intended to give retirement savers an additional source of income in addition to their retirement plan and IRA distributions.
LIRPs don’t offer the same tax benefits as qualified plans and IRAs, such pre-tax contributions or deductible contributions. They can offer some benefits that qualified plans and IRAs cannot match. Distributions from LIRPs are not subject to an age limit. These loans are tax-free and do not require you to be over 59 1/2. Except for a qualified exception, distributions made before the age of 59 1/2 by qualified plans and IRAs will be penalized. LIRPs often provide a guarantee of principal and interest to the investor, except when the investor is contributing to variable universal life insurance policies.
How to fund retirement with a LIRP
It is easy to fund a retirement plan for life insurance. You simply need to take out a cash-value life insurance policy that covers the coverage you desire, and then fund it by paying more premiums than required. The policy’s cash value will increase faster because the excess money will be deposited into it.
This type of retirement savings is the easiest because there are no rules. You can increase the growth rate of your policy by investing in a variable universal policy, which invests its cash value into the financial markets. This type of policy comes with more risk, but also offers more rewards. You could also invest in an index universal life policy. This policy will allow you to make money when financial indices rise, but not lose any money when they fall. It all depends on how risk-tolerant you are and what time frame you have.
You can receive tax-free distributions of your accumulated cash value as policy loans when you retire. If you have a Roth IRA, you can also take tax-free distributions. However, the Roth does not offer death benefit protection or limits on how much you may put into it each year.
Who needs a life insurance retirement plan?
A LIRP is a good option for retirement savers in three situations:
- High-income earners are those who contribute as much as they can to traditional retirement savings vehicles like IRAs or 401(k), and are now looking for other avenues to save for retirement.
- Families with children with special needs who need to be taken care of all the time. The death benefit will cover the costs of supporting the children in this situation.
- A LIRP policy offers tax benefits that can be used to pay estate taxes for high-net-worth individuals.
These are the main benefits and drawbacks of a life insurance retirement program:
| Pros | Cons |
|---|---|
| Distributions exempt from tax | Contributions that are not deductible |
| Tax-free death benefit | Higher costs |
| Guaranteed interest rate (Whole-life policies only) | Low interest rates may be possible |
| Growth potential (Universal Indexed, Indexed and Variable Policies) | Limited investment options, potential loss of principal (variable universal insurance only). |
| Benefit riders with acceleration | It may never be necessary |
| Estate taxes and provisions for children with special needs | Additional costs |
Most Frequently Asked Questions
Which are the best life insurance policies for a LIRP?
There is no “best” policy that can be used for a LIRP. It all depends on your risk tolerance, time frame and how much money you are willing to invest. Although indexed universal life and universal life policies have variable interest rates, they have performed better over the long-term than whole-life insurance. Variable universal life policies are a good option for risk-takers, as there is no limit to their earnings or losses.
What has the history of LIRPs?
Since the introduction of modern commercial cash value life insurance policies, LIRPs have been around. A LIRP could be set up by anyone who can afford the premiums. Since then, they have been used by higher-income customers. They have been more popular with the introduction of universal, indexable and variable universal policies. These policies allow cash value to grow much faster than traditional whole-life policies.
What is the risk of LIRPs compared with IRAs or other retirement plans?
It depends on the type of policy that you purchase for your LIRP and what other investments you make. Your principal will be guaranteed if you choose a universal, indexed, or whole policy. However, the interest rate can change with the latter two options. You can make substantial returns on your investment in a variable universal policy. However, markets do not always behave as expected.
Another thing to think about is the investment you make in your IRA, company-sponsored retirement plan, or any other investments. You are taking the same risk if you invest primarily in stocks as you would with a variable universal insurance policy. You are taking as much risk if you invest in CDs or government bonds than you would with a whole-life policy. It is possible that you are contributing to an IRA, qualified plan, or have a particular policy in mind for a LIRP. It may be a good idea to talk to your financial advisor about comparing them.