Planning for your retirement presents a dizzying number of options to choose from. There are literally hundreds of financial products that provide both the opportunity to build your nest egg and maintain its value. There has been a significant amount of buzz in the financial planning community recently regarding life insurance retirement plans (LIRPs).
To those seeking to build tax-deferred value and supplement their income during retirement, LIRPs can seem like an extremely attractive option. That being said, there are some drawbacks to choosing an LIRP over other retirement products. Like many retirement plans, an LIRP isn’t a good fit for everyone.
Is a life insurance retirement plan the smart option for you? Read this overview and weigh the pros and cons for yourself. An LIRP combined with other well-chosen retirement products may be that “secret ingredient” to your own recipe for a comfortable and secure retirement.
What is a Life Insurance Retirement Plan (LIRP)?
In brief, an LIRP is taking out a whole life policy and borrowing against its cash value to supplement your income from other retirement plans like a pension, Roth IRA or 401K. This plan only works with whole life insurance, as term life insurance policies do not accrue cash value.
The way the LIRP works is you pay the monthly premium for your whole life insurance policy, and in turn part of the money you pay in every month accumulates cash value over time. Some who choose an LIRP may also choose to pay extra into the account to pad the cash value and create a larger fund to draw on post-retirement.
After retiring, you can borrow against the cash value of the life insurance policy and use it throughout the years to supplement your retirement income tax-free. You read that correctly: tax-free. No paying a cut of your income from savings to the government annually.
The money you put in as cash value can be taken back out tax-free as a loan, and some policies even return the interest you pay on the loan to the cash value of the account. An LIRP is probably sounding fantastic right now; however, let’s take a closer look at the benefits and drawbacks of life insurance retirement plans before we jump to any conclusions about if they’re right for you.
Benefits of a Life Insurance Retirement Plan
Greater Financial Security
The primary benefit of investing in an LIRP is its guaranteed floor. This means the money you put into your whole or universal life policy remains yours and accessible for as long as you keep it.
The value of that balance does not go down unless you borrow against the policy and fail to repay the loan before your death. If you plan on keeping some of your money safe for the long haul, there are few products that offer a guarantee like an LIRP.
Stable Retirement Income
The cash value of your life insurance policy is not subject to stock market fluctuations. It may not be earning interest as it would in an investment account, but the trade off is that you keep those funds regardless of the current state of your portfolio.
A stable source of income that’s guaranteed can grant significant peace of mind post retirement, and having the death benefit for any dependents you leave behind only adds to everyone’s financial security. For many, that is well worth the cost of premiums and any fees or interest that may be assessed as part of using the cash value of the policy.
Funds from your life insurance policy’s cash value or loans taken out against it are tax exempt. Keeping as much of your money as possible without having it siphoned off annually for income tax is going to be a critical concern for most retirees, and setting up an LIRP can offer your nest egg significantly more protection against tax losses over time.
While taxes are one of life’s few certainties, you can at least mitigate their impact on your retirement income by preparing a tax-free source of income in addition to your pension, 401K or other retirement plans.
Chronic/Critical Illness Safetynet
There are whole life and indexed universal life insurance policies with accelerated benefits available to provide you with more coverage for your money. In addition to a death benefit, some policies also offer long term care and critical illness insurance, too.
Should you require long term care due to a chronic illness, your care would be covered so long as you continue to pay your premium. Moreover, if you are diagnosed with a critical or terminal illness, your care and treatment is also covered by your life insurance policy.
Bundling multiple products together is a great way to cut down on the cost of your premiums and prepare for worst case scenarios should you suffer a setback in your health. If you are planning to take out a whole or universal life insurance policy for your life insurance retirement plan, it would be prudent to see what other products your insurance company offers that may be to your long term benefit, too. Life happens, and it’s worth your while to ensure you are covered no matter what life brings your way.
Drawbacks of Life Insurance Retirement Plans
Let’s get the major drawback out of the way first: whole life insurance policies can be expensive. Depending on your health, age and other risk factors, you can end up paying a significant amount of money. This would be monthly or annually for your life insurance policy.
The high cost of a cash value policy like whole life or universal life insurance is what typically sends investors with more limited capital searching elsewhere for their retirement needs.
You can technically access the cash value of your policy at any time or any age. However, the insurance company may have some rules in place. These are determined by how long you’ve held the policy and the total accrued cash value.
Insurers may also impose limits on the number withdrawals per year and charge administration fees for accessing your money. Some may actually reduce the death benefit of the policy if your cash value falls below a certain balance.
Additionally, taking loans against your cash value may accrue interest until the amount is paid. And, further add to your LIRP costs. Moreover, if there is still money due after your passing, it may reduce the death benefit if the loan is not paid.
It’s a risk versus reward balance. But depending on the policy terms you could end up losing more money than you keep. It’s a good idea to work with an insurance agent and a financial adviser. They can help you find the best policy that offers the greatest benefit as part of your LIRP.
Long Term ROI
As investment and retirement programs go, an LIRP does not offer much in the way of a long term ROI. Most advisers recommend it only if their client has already maxed out their contributions. Or if they hit their limit for an IRA or 401K. Setting up an LIRP allows investors a way to retain their hard-earned money. And without most of it being taxed away before retirement.
To be effective, a policyholder using a whole life insurance policy for an LIRP needs to “overload” their cash value. This is to get a worthwhile return on the money. If you have a high tax liability and your other retirement products are maxed out, then you are in the right league to start considering an LIRP.
For individuals who haven’t already maxed out their existing retirement plans, it’s best to consider buying term life insurance. This protects loved ones and invest what they would be spending on a policy into maxing out their retirement. This ensures a minimal tax-liability for the lowest cost. It also provides the most value for your money in long term savings.
Timing Is Everything
After a certain age, premiums increase dramatically. Buying a whole or universal life policy does not offer as significant a benefit. This is because the monthly or bi-annual premium is so high it negates income from the loan or cash value. You also need to give your policy between ten and fifteen years to grow its cash value. Otherwise it won’t offer you any tax-free income benefits.
Conversely, you also don’t want to take the policy out too soon and pay more in premiums. Consider when you will need your supplemental retirement income and calculate that age. Then buy a policy that will offer you the greatest cash value benefit along that time table.
Time your investment in a policy correctly, and you will find you have a steady, stable source of post-retirement income. This would remain untouched by the taxman year after year.
Choosing the LIRP That’s Right for Your Future
Setting up an LIRP isn’t a process that should be undertaken lightly or quickly. Consulting with a financial advisor or firm, a highly qualified insurance agent and a tax specialist are all highly recommended. This helps maximize the benefits of an LIRP.
It’s especially important to be aware of the potential costs associated with getting your LIRP started. As well as maintaining it until retirement.
Talking to your financial advisor is the best place to start. They can advise you whether an LIRP is a smart investment for you. This is based on your current portfolio and retirement plan.
It may be more advantageous to invest in term life insurance and withhold more money for your 401K or IRA. LIRPs are really only a good option if you have maxed out the limit on your current retirement accounts. And, need a way to keep putting money away not reported as income when you draw on it post-retirement.
Moreover, if your LIRP policy is the only life insurance you plan to carry, you want to be well aware of what compromising the death benefit with loans could be long term.
Speak with an Insurance Agent
Consulting with an insurance agent to find the best policy is critical to your success, too. You need a policy that you can maintain in good standing until you start taking money out. Or borrowing against the cash value.
Failing to maintain your policy for the required number of years before drawing on its cash value may negate any benefit your policy has to offer after retirement. That means all the money you’ve paid out in premiums is essentially valueless when your policy is cancelled.
The cash value of the policy is still yours, but your premium costs are essentially money that’s not coming back. If you are putting money into an LIRP to have tax-free income after retirement, you will need a policy you can maintain no matter what.
Finally, talk to a tax specialist about how an LIRP would affect your specific tax situation. Despite the tax-free income stream, you may be spending more money establishing the policy. As well as its cash value, than you would pay in taxes on disbursements from another retirement product.
All in all, getting all the information you can to make an informed decision is what matters most. Getting expert help is going to make the process significantly easier. It will also help prevent an expensive mistake if a life insurance retirement plan isn’t right for you.