A LIRP is a retirement program that keeps retirement funds in the cash value of continuous life insurance policies.
This article examines the operation of an LIRP and considers some advantages and disadvantages of a life insurance-based retirement plan. We’ll consider more tax-aware retirement funding options as well.
Defining a Life Insurance Retirement Plan (LIRP) and Providing Examples
A LIRP is a retirement plan that holds retirement funds in the cash value of everlasting life insurance contracts, like whole life and comprehensive life insurance. Putting up cash reserves that you can use to add to your retirement funds is a requirement of the plan. In the end, you may be able to withdraw money from your cash value or borrow against your policy to pay for items in retirement.
If a person currently has a life insurance plan with a sizable cash value and no longer requires insurance protection (or won’t when they retire), using life cover for income may make sense. The tactic may also be attractive to people who seek to reduce market risk, albeit there may be better options available.
Life insurance firms emphasize that utilizing your policy for pension could have a negative influence on your coverage and that it should only be used as an added benefit to other retirement plans.
What Is the Operation of a Life Insurance Retirement Plan (LIRP)?
Policies with permanent life insurance have a cash value that can increase over time. When you put premiums to a policy, you often pay more than is necessary to maintain your policy and give life insurance protection. The extra cash increases the cash value. Any increase in your cash worth is tax-exempt, and over the course of several years, you could amass a sizable sum.
Your cash value represents the source of your extra income when you have an LIRP. Through withdrawals or loans secured by your insurance, you can access cash value. Even if neither of those kinds of income is taxable, there are restrictions and negative outcomes that could result from using your cash value:
Withdrawals may be subject to taxation once you’ve taken more money out of your policy than you put into it.
Loans incur fees for interest, and any outstanding loan balance at the time of death reduces the death benefit payable to your beneficiaries.
Keep surrender fees in mind if you make withdrawals. The insurance company may impose penalty costs that lower the proceeds if you are still in the surrendering period, which is normally the early years of the contract but can extend up to 20 years. This depends on how long you have had your policy.1
You must be mindful of tax regulations while adding permanent life insurance to your cash worth. For instance, if you make a contribution that is more than what the IRS permits, the policy may change to a modified endowments contract (MEC).2 Because the withdrawals you make are more likely to be taxable, that result would undercut a plan that uses life insurance as a possible source of tax-free retirement income.
In contrast to a withdrawal symptoms, interest is levied on a loan on the amount that was “loaned,” however the same amount may continue accrue interest as part of the value of the money. Life insurance loans have no impact on your debt-to-income ratio, which determines your capacity to borrow for mortgages and other loans, according to Cynthia Meyer, CFP® of Real Life Planning. You are also exempt from the requirements for a life assurance loan. Regardless of how good your credit is, you can obtain the funds if they are available in the form of money worth.
Life insurance shouldn’t be utilized mainly as a retirement vehicle, according to Meyer. However, you can see the money from an insurance with a sizable cash value as a bonus to add to your current retirement plan.
LIRP Case Study
Despite the risks, term life insurance policies make getting money pretty simple. Loans and withdrawals, as opposed to accounts for retirement like IRAs and 401(k) plans, can make it simple to access tax-free money prior to age 59 12.
Consider the ideal case where you and your loved ones have an outdated permanent life insurance policy. You can withdraw further income from the policy if your existing tax status makes it unfeasible to cash in the policy and redeploy the funds (or if you like the concept of having the death payout in place throughout retirement).
You need a sizeable amount of value in cash in a lifelong insurance policy in order to use life insurance as a supplement to your retirement income.
Whole life coverage, universal life, or variable life policies are just a few of the several types of policies available. When it pertains to cash value growth, whole life insurance normally offers the greatest degree of certainty; nevertheless, returns from universal and changeable policies may one day surpass those from whole life policies.
If you choose to take money from a policy, you may do so through withdrawals or loans. To avoid selling assets in your IRA at significant losses, it can make sense to collect income from a policy of life insurance instead if assets in your IRA lose value due to a market meltdown.
To prevent a policy lapse, you must, however, make sure that your life insurance plan has enough cash value remaining. According to Meyer, if you borrow or take too much, the policy may lapse and you may be forced to pay the taxes you were hoping to avoid.
If your policy expires or if you remove more money than you contributed to the policy, using the remainder as cash could have tax repercussions. Despite the fact that loans are not taxable, outstanding loans lower the amount that your beneficiaries receive and can make your policy expire, which may lead to taxation.
LIRP Advantages and Disadvantages
Beneficiaries will get a death benefit if you maintain the policy in force.
When employing entire life insurance, the possibility of assured values
For some items, the ability to avoid market losses
Early tax-free income withdrawal possibility Drawbacks
Unless you give up the coverage, you are unable to use every penny of your money.
Possible tax repercussions following an unplanned lapse
Standard long-term investments may provide more potential for long-term growth.
It may not be wise to pay premiums for life insurance cover.
Loan interest rates
Life insurance can offer a death benefit to support your loved ones after your passing if you keep the policy in force, which means you don’t surrender it for its cash value or let it lapse. A whole life policy offers a stable growth rate and an assured cash value that you can benefit from in the future if you can’t handle the fluctuations of the markets.
The money you save up in a life insurance policy can’t be used all at once, though. Keep enough money in the policy to cover insurance premiums and other internal expenses. That can make you wonder if it’s really worthwhile to pay those taxes in the first place.
Insurance for life might not be the most advantageous choice when compared with alternative retirement resources like an IRA. Interest fees are incurred when borrowing against your insurance, a cost that is not incurred when taking distributions from retirement savings. Additionally, withdrawals in excess of the life insurance contract’s basis are taxed. The costs and crediting mechanisms in an insurance policy could not yield as much growth as investing in an IRA, if you’ve got the time and tolerance for risk to invest for growth.
Once you reach the age of 59 you can take money from a Roth IRA tax-free up to the value of your contributions made before to that age.
Alternatives to LIRPs IRA include individual retirement accounts (IRAs), which offer tax-deferred growth and allow you to withdraw 100% of your balance without incurring loan interest or having to worry about a policy lapse. Your retirement withdrawals may be tax-free if you select a Roth IRA and meet IRS conditions.
You can save a lot more money through workplace retirement plans such as 401(k), 403(b), and various other programs than an IRA. With the help of Roth 401(k) along with Roth 403(b) alternatives, you might be able to build up significant assets for future tax-free income.
HSA: When utilized for certain medical expenses, Health Savings Accounts (HSAs) may provide pre-tax investments, tax-deferred growth, or tax-free withdrawals. However, choosing specific high-deductible health plans is the only way to be eligible for contributions.
Accounts that are subject to taxes: Regular single or joint investment accounts give investors full control over withdrawal and investments. Although these accounts don’t offer tax advantages, you can still invest using tax-aware tactics.
In the event that you have exhausted all other retirement options, annuities offer tax deferral. Additionally, annuities provide insurance company assurances like lifetime income.
Term life insurance and a taxable or retirement account: Term insurance may be able to cover your loved ones for a predetermined period of time if you don’t have a long-term need for a death benefit, allowing you to “invest the difference” in an investment vehicle like an IRA or stock account. (The phrase “investing the difference” refers to the price difference between a permanent and a term life insurance policy.) Determining whether your demand is short or permanent is crucial, though. Before choosing a life insurance agent, discuss your objectives with a few of them.
Surprisingly, the average state and federal income tax rate for retirees in the United States is 6%.5 The wealthiest families in the United States might profit from life insurance policies more than the typical family, but it’s important to consider the full picture, and taxes are only one aspect of it.
Can Life Insurance Be Used to Fund an Early Retirement?
Life insurance is simply one of the options for funding an early retirement.
With perpetual life assurance, you can borrow money or make withdrawals at any age. As long as your withdrawals don’t exceed your foundation, which is typically the sum you paid into the policy, no taxes are required. However, some strategies, like a Roth IRA or taxable trading account, let you access your money without paying interest or keeping money in reserve to prevent a policy lapse before you reach the age of 59.
For instance, Roth IRAs allow for the tax- and penalty-free withdrawal of recurring contributions at any time. You can set up a series of roughly equal periodic payments, or 72(t) payments, if you have money in before taxes retirement funds, to avoid paying early withdrawal penalties.6 As an alternative, you might be able to make withdrawals without paying an early withdrawal penalty if your job offers a 457(b) plan.
Your taxable holdings are often accessible at any time, and the tax consequences of taking long-term capital gains may be tolerable. In light of the fact that tax regulations are subject to change and that mistakes can be costly, discuss your choices with a CPA.