As experts in life insurance retirement planning, we recognize the growing importance of Life Insurance Retirement Plans (LIRP) as a foundational asset for financial security and stability. Tapping into our 70+ combined years of life insurance experience, we delve into the world of LIRPs, a distinctive form of permanent life insurance that uses a cash value component to provide retirement income, without fear of losing your principal.
Table of Contents
- Key Takeaways
- Introduction to Life Insurance Retirement Plans (LIRPs)
- How LIRPs Work
- Understanding LIRP Policy Structures for Cash Value Growth
- Benefits of LIRPs: Pros Explained
- Navigating the Challenges: Cons of LIRPs
- Choosing a Company that offers the Best LIRP
- Comparison with Other Retirement Plans
- Addressing Retirement Concerns: LIRPs tackle critical retirement planning concerns such as longevity risk, market volatility, cognitive decline, and inflation, ensuring comprehensive financial security.
- Benefits of Permanent Life Insurance: LIRPs utilize permanent life insurance policies, like Whole Life or Indexed Universal Life, to provide lifelong coverage, an increasing cash value account, and a growing tax-free death benefit.
- Protection from Market Volatility: LIRPs serve as a hedge against market downturns, offering an uncorrelated asset that can supplement income during poor market years without the risk of losing principal.
- Cognitive Decline and Long-Term Care: With options for critical illness and long-term care riders, LIRPs provide financial resources in the event of cognitive decline or the need for long-term care.
- Tax Advantages and Flexible Access: LIRPs allow for tax-free income through withdrawals and loans against the cash value, providing flexibility and tax-efficient retirement income.
- Legacy and Estate Planning: Beyond retirement income, LIRPs offer a tax-free death benefit, ensuring a financial legacy and estate planning advantages.
- Comprehensive Retirement Strategy: While not suitable for everyone, LIRPs can be an essential part of a diversified retirement strategy, especially for those looking to mitigate risks and secure tax-advantaged income.
The problem: too often people are held captive to the highs and lows of the stock market, which provides much uncertainty and fear, particularly as one nears retirement.
The solution: Provide a safe and stable alternative that you can store your savings in that provides a decent rate of return but with limited to no downside.
There are 4 areas of concern that should be addressed as part of any retirement financial planning:
- 1. Longevity Risk
- 2. Sequence-of-Return Risk due to Market Volatility
- 3. Cognitive Decline
- 4. Inflation
How permanent cash value life insurance addresses each of these problems.
1. Longevity Risk: A properly designed permanent life insurance policy will last your entire life and provide an increasing cash value account and increasing tax free death benefit.
2. Sequence-of-Return Risk: a volatile stock market is always a concern for someone nearing retirement or at the beginning of their retirement. One bad year and it can greatly effect your retirement plan and how much you can withdraw from your account. Having an asset such as whole life insurance that is not correlated to the stock market can give you an alternative cash flowing asset to draw from in bad market years.
3. Cognitive Decline: Both Indexed Universal Life and Whole Life have riders that provide critical illness and long-term care protection. Also, asset-based long term care products are also available that mix permanent coverage and long-term care insurance into one.
4. Inflation: As mentioned above, a properly designed permanent life insurance policy will last your entire life and provide an increasing cash value account and increasing tax free death benefit. This will help you hedge against inflation.
The life insurance retirement plan, a/k/a a LIRP, is a powerful financial tool that we have seen firsthand provide many benefits and has been used by millions of Americans to protect and secure their financial future. It is a permanent life insurance policy with a cash value component, focused on capital preservation and compound growth, without the fear of loss.
The following LIRP video below provides a real-life case study. The video is focused on retirement planning and offers an excellent breakdown of the benefits of a LIRP powered by whole life insurance.
A LIRP works by taking a properly structured cash value life insurance policy, that is designed for maximizing the cash value growth, and uses it as an alternative source of income in retirement. The cash value provides the tax-free income through withdrawals and policy loans.
A Term life insurance policy is not going to work for a LIRP. Term life insurance provides death benefit protection and does not have a cash value account. And a guaranteed universal life insurance policy will not work as it typically is designed for permanent life insurance coverage but very little, if any, cash value growth.
A LIRP can be created using any number of permanent life insurance companies and policies. You can choose participating whole life, indexed universal life and variable universal life. Each type of life insurance coverage has its pros and cons associated with it.
A whole life insurance policy offers fixed premiums and fixed costs. An indexed universal life insurance policy provides 0% loss protection but potential for higher gains than whole life. And in our experience, a variable universal life insurance policy is not generally recommended for a LIRP due to its inherent volatility and associated risk.
Comparing Different Life Insurance Policies
The two best permanent life insurance policies will be either:
The good news about either of these permanent life insurance policies is they can be properly structured so that the focus is on growing your cash value versus a large initial death benefit. The death benefit can grow over time, but the primary purpose of the LIRP is to act as a retirement plan, providing an alternative income source to other retirement accounts such as the 401k and IRA.
Freedom to Spend Other Assets
A permanent death benefit allows for more flexibility in spending other retirement assets. If you know that your beneficiaries will receive a tax-free death benefit upon your passing, you can freely spend down other assets.
Increased Social Security Benefits
Using your life insurance policy’s cash value as income can delay taking Social Security, leading to higher benefits. For each month you wait to start your benefits, your monthly benefit will be higher—for the rest of your life.
Protection From Losses
For many Americans that had saved with traditional investment strategies, the crash in 2008 was enough to devastate their portfolios. Many saw more than 50% of their portfolio given back to the market in massive sell-offs.
And while it’s true that these Bear markets are typically followed by Bull markets, that isn’t a solid encouragement for those that planned on retiring in 2009 or 2010, who suddenly had to get a lesson on sequence-of-returns risk.
A Guaranteed Floor
Depending on the chassis you choose for your LIRP, either whole life or indexed universal life, a LIRP provides a floor to your investment returns, also known as a guarantee. The guarantee means that you will never have a year in which you take a loss, and depending on your product choice and cash value allocation you may be able to get a guarantee that you’ll never get less than 3 or 4%.
In order to get the guarantee and the safety that comes along with it, you will give up some of the big gains that come in the incredible bull market years.
So you won’t be getting 20% when the market is booming, instead you may only get 10%. But for many that is a price they’re more than willing to pay to get a solid guarantee that they’ll never lose money, and not losing money is the key to true compound interest returns.
Guaranteed Death Benefit
In addition to guaranteed returns, you also get a guaranteed death benefit. The life insurance death benefit is paid to your beneficiaries income tax free.
And the tax free death benefit on a life insurance retirement plan can be designed to increase each year as your cash value grows, so when you do die, your beneficiary receives the maximum death benefit possible. It is also a great way to hedge against inflation, as the purchasing power of our dollar is cut in half every 25 years.
Retirement Income in Life and Replacement Income in Death
In life, your LIRP can be used as tax-free income via withdrawals up to your basis or you can borrow against your cash value. Having a steady stream of tax-free income from your policy is a great way to supplement your retirement income.
In death, a life insurance retirement plan provides income protection in the event that you can no longer provide that retirement income for those you love. In the event of your death, the LIRP provides a tax free death benefit to your beneficiaries.
Long Term Care
And if you have chosen the disability features within a LIRP, you can even provide for you spouse and family if you are permanently disabled, need long-term care or are terminally ill via long term care and chronic illness riders.
While the goal of properly designed Life Insurance Retirement Plan is to provide living benefits for you and your loved ones that last your entire lifetime, one of the key benefits is that it also provides death benefit protection if you die unexpectedly.
The peace of mind that comes from a LIRP is a great advantage, and it’s one reason why the LIRP is sometimes considered a self-completing retirement plan.
Hedge Against Rising Tax Rates
Most retirement strategies are either fully taxed, or tax-deferred. What that means is that you either pay taxes every year on the gains you receive from your investments (fully taxed), or you defer taxes on your gains and pay them when you withdraw your funds (tax-deferred).
The LIRP is not like either of these strategies, it is tax-free.
How can a LIRP be tax-free?
First and foremost the money that you invest in typical tax-deferred investments is paid for with pre-tax money. Whereas with a LIRP you pay for it with after-tax money.
So the government has already been paid to some degree. But what about the gains in your investment – when do you pay tax on those?
With a LIRP you will pay taxes on the gains if you choose to withdraw the money.
However, the gains don’t have to be withdrawn to be accessed. You can choose to borrow from your gains instead of withdrawing, and thereby gaining access to your money tax-free.
What about Interest?
The typical question about borrowing from a LIRP is “If it’s a loan, don’t I have to pay interest?”
The answer is yes, and no.
You do pay interest when you borrow from your LIRP, but due to the fact that you also receive interest from your LIRP, the loan typically ends up being a wash loan. These loans are often called wash loans because you earn what you pay, so it’s a wash.
But what does all this have to do with a hedge and rising tax rates? A hedge just means that something is a barrier, or a protection against, something.
In this case, having a tax-free retirement vehicle means that tax rates can rise to 50% and it won’t impact your retirement because you will be accessing your funds tax-free.
In other words, the tax situation for those with life insurance retirement plans are much more secure and predictable than those with other strategies where paying taxes is involved.
Penalty Free Loans and Withdrawals
With a LIRP, you can access your money without penalty for anything you need it for, including an investment opportunity that may arise. One way to access your money is a withdrawal. You can take out as much as you need up to your basis and not be taxed. Additionally, you can take out a tax-free loan by borrowing against your cash value, producing a tax free income stream.
A 401(k) may allow you to do the same thing, but the access to your money comes at a cost. With a 401(k) plan, if you access your money prior to age 59.5, you will pay a early withdrawal penalty. The penalty for early withdrawals that don’t meet the hardship criteria is 10%, and of course you are taxed on these as well.
To those that have never heard of Infinite Banking or Be Your Own Bank, it’s a concept that allows you to use your LIRP to fund various financing endeavors for yourself or others.
In order to be your own banker, you need to use your saved money within the LIRP to finance various ventures, such as purchasing cash flowing assets or investing in your business. You then use the proceeds from your investment to pay back your loan, repeating the process as opportunities arise.
Life Insurance Retirement Plans also provide protection against the high cost associated with long-term care. Most LIRP policies provide for accelerated death benefits that can be used if you are diagnosed as terminally ill.
You can even add additional long-term care riders or chronic illness riders for further protection, providing access to your death benefit while you are still alive to cover costs such as nursing and in home care.
High Funding Limit
For those who are below the income requirement threshold for funding a ROTH IRA, there still is the problem of limitations on how much you can put into the Roth IRA. Currently, the maximum you can contribute to a ROTH IRA is $7,000 under age 50 and $8,000 over age 50.
However, there are very high limits on how much you can place into a LIRP, generally a multiple of your income based on your age. And there is no income threshold prohibiting you from funding a LIRP, beyond what you can qualify for. That is why cash value life insurance is referred to as the “Rich Person’s Roth.”
When it comes to the negatives of a LIRP there are two primary areas that detractors focus on. One area is price, and the other is the growth rate. We will address both of these challenges.
LIRP’s Are Too Expensive
When someone says a LIRP is too expensive, we have to ask, compared to what? And the “what” is always term life insurance. The reason this is insincere is because term life only lasts for a period of time, has no cash value, and lacks many of the benefits of a LIRP.
Most financial advisors that are critical of LIRPs like to compare term vs whole life insurance to shock the reader into a state of disbelief.
Often such comparisons will posit the cheapest term insurance to the most expensive permanent life insurance. And the person making this comparison will repeat the financial mantra “buy term and invest the rest“.
The problem is, no one actually does this. And the idea that you can simply self insure is disingenuous.
For one, no one knows when they are going to die. And with a LIRP, you get a leveraged death benefit that pays out income tax free to your beneficiary.
And two, with a properly designed policy your death benefit grows. So that when your number finally does come up you have a much larger death benefit then when you began, creating a legacy that will most likely exceed anything you could have obtained to had you listened to the status quo advice of financial advisors who want to grow their AUM (assets under management).
LIRP’s Slow Growth vs Stock Market
Most financial entertainers bash permanent life insurance because the returns are lower than the stock market’s historic average return. However, consider that a life insurance retirement plan can be used to supplement investment accounts in down years to protect against sequence of returns risk.
Sequence of Returns Risk
When the market drops 20-40% in a year, the last thing you want to do is take money out of the account for retirement income. That is one way a LIRP provides financial protection in retirement, as it offers an alternative source of income when the market has down years.
Average vs Actual Returns
We also need to consider actual returns vs average returns. If you get a 100% return in year 1, and a negative 50% return in year 2, your account balance would be the same as when you started which is an actual return of 0%. But if you add the two years together (100-50=25) you get an average return of 25%. So you see how math can be manipulative and make people think they can get a greater return that what they actually get.
Further, consider how five consecutive years of 10% returns can be easily wiped out by one -40% return. And to make matters worse, you have now lost 6 years.
Keep in mind this is only comparing rate of return, we haven’t even talked about how much of the money you get to keep (taxes), or how easy it is to access your money.
There are three things to consider when choosing a company for the ideal life insurance retirement plan.
- The ideal LIRP is with a reputable mutual insurance company. We believe mutual companies that are beholden to the policy holders are better choices than the companies that only answer to their shareholders.
- The ideal LIRP is with a company that has a proven track record of performance. Not all life insurance companies have great returns year after year. We recommend choosing companies that have historically outperformed their competitors, such as companies with a history of excellent life insurance dividends, or higher participation and cap rates.
- The ideal LIRP is with a company that is top rated, flexible and allows for a variety of options. You never know what the future holds, and therefore having a life insurance retirement plan with a company that provides financial security and policy flexibility is a huge bonus.
In this section we break down how a LIRP stacks up to other retirement plans such as the 401(k) and an Individual Retirement Account (IRA).
401(k) & IRA
1. Maximum annual contribution limits.
Participants in traditional IRAs and 401(k) plans are only allowed to contribute up to a certain amount each year. With a LIRP, there is no statutory maximum contribution limit.
2. Required minimum distribution (RMD) rules.
When a traditional IRA and 401(k) plan participant turns 73, they are required to start withdrawing at least a certain amount from the account every year going forward. If they don’t, they will face a financial penalty from the IRS. With a LIRP, there are no RMDs.
3. IRS early withdrawal penalty.
With an IRA or 401(k) plan, if you withdraw funds before turning 59 ½, you could incur a 10% “early withdrawal” penalty from the IRS. This is in addition to any taxes that you owe. In contrast, a LIRP does not have early withdrawal penalties.
4. Withdrawals are usually 100% taxable.
Another significant drawback to traditional 401(k)s is that withdrawals are usually 100% taxable. With a LIRP, withdrawals up to your basis in the policy are tax-free and you can also take out a tax-free life insurance loan, using your death benefit as collateral.
5. No Death Benefit
Most people considering a life insurance retirement plan are not focused on the death benefit but one thing that needs to be said is that a LIRP has a death benefit and a 401(k) and IRA do not. So if you die prematurely, your family is financially protected with a LIRP, but not so much with an IRA or 401(k).
As experienced professionals with backgrounds in Life Insurance and Estate Planning, we at Insurance and Estates firmly believe that a Life Insurance Retirement Plan (LIRP) is a vital component of a robust financial strategy.
Our deep dive into the LIRP concept has shown that, while it may not be the perfect fit for everyone, it offers unique advantages such as tax-free retirement income, flexibility, and financial security. It’s a powerful tool especially beneficial for those seeking to diversify their retirement portfolio and mitigate risks like market volatility and rising tax rates.
We encourage individuals to consider how a LIRP might align with their long-term financial goals and to reach out to us for tailored advice and insights on incorporating this strategy into their retirement planning.