Life Insurance Retirement Plan (LIRP)
A LIRP is a savings strategy that mimics many of the tax-free characteristics of the Roth IRA. It works by purchasing a cash value life insurance policy that the owner then heavily overfunds for at least 10 years. Since the owner overfunds the policy the cash value grows more aggressively than a traditional cash value life insurance policy where smaller payments are spread over a longer period of time.
For illustrative purposes consider the following example. A $300,000 whole life policy for a healthy 30 years old male would cost about $1,800/year for life. Needless to say, there isn’t much growth in the cash value that is to be expected for the first 6-8 policy years. On the other hand, that same policy, structured to be paid with only 10 payments would cost about $6,000/year for 10 years, at which the policy will be paid off and no more premiums are due (aka “paid up” in insurance terms). By condensing the payments into larger amounts over shorter periods of time you allow for greater growth potential due to the power of compounding. As you might expect, due to its design, the second policy would have a significant amount of cash value by the 4th or 5th policy year. In addition, 10-pay policies usually have much lower commissions paid out to brokers than policies that are paid for 20+ years. These savings are passed down to you and help grow your cash value faster.
Although the primary purpose of this strategy is not to provide a death benefit, a properly structured LIRP is still considered a life insurance contract in the eyes of the IRS. As such, it is given favorable tax treatment that is not afforded to other savings/investment vehicles.
How A Life Insurance Retirement Plan compares to other retirement accounts
The cash value in the policy grows tax-deferred and very closely resembles a traditional IRA
The owner can structure tax-free payouts from the policy using withdrawals and/or loans. Similar to a Roth IRA, the owner can withdraw their contributions (known as basis) at any time without any penalty or income tax liability. If the owner needs to withdraw more than their contribution then a loan can be taken out against the policy. Under current law, loans from life insurance policies are not taxable
Death benefits paid to the beneficiaries are income tax free. This is a very similar feature of Roth IRAs as both provide such a benefit. However, with a Roth IRA, the funds need to actually be in the account to provide the inheritance. Life insurance on the other hand provides an immediate payment of the death benefit, regardless of how many months or years an owner funded their policy. For example, you are approved for a $100,000 life Insurance policy for 40/month. On March 1, 2018 you make your first premium payment but 5 days later you are killed in a car accident. Your small $40 payment just turned into $100,000 for your loved ones. This feature is known as an “immediate estate” and Life insurance is the ONLY product that offers such a benefit.
There are no Required Minimum Distribution (RMD) requirements. Similar to a Roth IRA, this feature of LIRPs do not unnecessarily force the policy owner into a higher tax bracket by requiring withdrawals.
Life insurance, depending on the state, may offer protection from creditors. This is similar to most retirement plans (within federal/state limits)
Unlike withdrawals from a Traditional/ Roth IRA, withdrawals from a life insurance policy do not come with any strings attached. You don’t need to be disabled, age 59 1/2, or use the funds for any specific reason to make a tax-free withdrawal.
Unlike most early withdrawals from a traditional/ Roth IRA, withdrawals from a life insurance policy do not incur a 10% early distribution penalty.
Who should consider a Life Insurance Retirement Plan?
A LIRP is an appropriate investment for individuals:
Who are in pretty good health
Who have some need for life insurance
Who have fully funded all other qualified retirement accounts (IRA, 401k, 403b, SEP IRA, etc.)
Who would like to put away additional tax advantaged dollars for retirement
Who can afford to overfund life insurance premiums for at least 10 years 6. Who have a longer time horizon (15+ years)
A LIRP may be an ideal solution for individuals to save excess dollars to:
Supplement existing retirement savings or those who don’t have the discipline to save on their own
Provide a tax advantaged alternative to using a savings account as an emergency fund
Provide funds for a down payment on a property
Cover the cost of college education for children & grandchildren
Estate planning and minimizing estate taxes
Providing a legacy/inheritance
Or to fund practically any other big ticket items (wedding, cars, vacations, etc.)
How to fund a LIRP?
There are 3 life insurance products commonly used for a LIRP.
They are:
Whole Life insurance,
Indexed Universal Life Insurance, and 3) Variable Universal Life Insurance. Keep in mind that the first 2 products, Whole Life and Indexed Universal Life, are guaranteed to never lose value but their returns are limited. For those willing to take on some market risk and potentially achieve better investment returns, Variable Life Insurance provides a powerful combination of an investment and insurance policy, yet still maintains all the tax benefits of a traditional insurance product. The LIRP strategy is fairly complex and requires careful structuring of a life insurance policy. It is important to discuss with a qualified Advisor before this strategy is implemented to ensure the life insurance policy is set up properly. When done correctly, a LIRP: 1. Maximizes cash value for the owner by minimizing commissions and fees earned by the Advisor 2. Is structured to avoid MEC status and retain all the tax advantages of a life insurance product