LIRPs (Life Insurance Retirement Plans): Should You Use One?

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Fast forward a handful of years, or maybe decades. You’re done. You’ve stood up from your desk or punched your timecard for the last time. You’re officially retired, but it begs asking how you’re going to support yourself in your leisure years.

The Social Security Administration estimates that average monthly retirement benefits are $1,503 as of 2020. You might have retirement savings to bolster your benefits, but it’s generally recommended that you don’t take more than 4% a year. That might not be enough even when added together.

Millions of Americans have turned to Life Insurance Retirement Plans or LIRPs to bridge the savings/benefits gap in their later years. Earnings are tax-deferred until you withdraw the money, and you can take tax-free withdrawals from the cash you’ve contributed whenever you want it, subject to some rules. The life insurance component will pay your beneficiaries tax-free at the time of your death.

How an LIRP Works

The LIRP equation begins with purchasing a whole life or other cash value insurance policy. The premiums you pay will cover two components: the life insurance policy itself and contributions to an investment account that represents the cash value of the policy. Both death benefits and returns on investment are typically guaranteed.

You can draw money from the policy’s cash value tax-free up to your basis in the policy. Contributions to an LIRP are treated similarly to those made to a Roth IRA with already-taxed dollars, so you won’t have to pay taxes again when you take those contributions out. Another option is to take a tax-free loan against the policy's cash value.

Most policies offer the option of paying more than your set premiums each month to add to the cash value account, and you can maintain minimum death benefits so more of your money goes to the policy’s cash value, but only up to a limit.

Not All Policies Have Cash Value

Not any old life insurance policy will do here. The policy must have cash value, and term life policies do not. These policies are purchased to cover you for a set period of years, usually 20 or 30, and all they’ll do is pay benefits to your designated beneficiaries at the time of your death – provided that you die while the policy is in effect.

Whole life, participating whole life, variable universal life, current assumption universal life, and indexed universal life policies have cash value, and all can be used to fund an LIRP. Some might be better for your needs and goals than others, however, depending on how you want to invest:

  • The cash values of basic whole life policies and current assumption universal life policies are typically included in the insurance company’s portfolio.
  • Indexed universal life policies are linked to the performance of a predetermined stock market index, as the name suggests. You can usually change up your indexing options if you think it’s necessary.

The Advantages of an LIRP

Saving in an LIRP can make a lot of sense for some individuals because of a few key advantages:

  • Investors in higher tax brackets can take comfort in knowing that none of that investment growth will be taxed until it’s taken out, and you might presumably be in a lower tax bracket after retirement.
  • Some policies offer guaranteed returns so you don’t have to worry about losing money if the market takes a dip.
  • Loans from cash value are tax-free and come with flexible pay-back terms with no late penalties. The interest you’ll pay on the loan is effectively paid to yourself.

The Disadvantages of an LIRP

Naysayers argue that this type of savings plan isn’t for everyone.

  • Whole life policies are expensive – up to 10 times more costly than term policies. You’ll need sufficient income to fund one, even after you retire.
  • Associated expenses and fees will increase with the size of the life insurance component and can depend on your age. They can potentially offset any gains earned by the cash value.
  • Some insurers limit the amount and frequency of withdrawals you can take.
  • You can be stuck with the investment options you choose in the beginning if you don’t take care to select a policy that allows you to make adjustments as time goes on.
  • Any cash value loans you take – plus interest – can be subtracted from the policy’s death benefits if you die before you repay the loan.
  • Returns can be significantly less than from some other investments, especially in bull market years, and any worthwhile growth takes a long time, typically at least 10 years.

Perhaps the most significant drawback, however, is that meeting the tax-free and tax-deferred provisions of an LIRP can be something like walking a tightrope. The policy must comply with IRS rules for maintaining a minimum amount of life insurance. Your premiums must be such that this minimum is met and there’s enough left over to make the cash value a viable component.

Payments toward the policy’s death benefit must represent a certain percentage of your premiums. Otherwise, Section 7702 of the Internal Revenue Code tags the policy as an MEC or “modified endowment contract,” and you’ll lost many aspects of the LIRP’s tax-advantaged status.

A Comparison With Other Retirement Plans

An LIRP might not be the best “either/or” option – your financial situation is such that you can fund either an LIRP or a more traditional retirement vehicle such as an IRA or 401(k), but you can’t afford to do both. An LIRP ideally supplements traditional retirement savings. For example, you can leave your IRA alone in a down market, giving it time to recover, and tap into your LIRP during these times instead.

If you have to make a choice between one or the other, keep in mind that your employer is probably making matching contributing to your 401(k) if you have one. That’s not going to happen with an LIRP, so you’re leaving cash on the table. But while you can typically take loans from your 401(k), the terms tend to be far more restrictive.

On the flip side, you can get to the money in an LIRP at any time – there are no age restrictions like there are with an IRA or 401(k), where withdrawals taken before age 59½ are subject to a hefty 10% tax penalty. And you can fund as much money into an LIRP as you like, while the IRS imposes limits on how much you can contribute each year to traditional retirement plans.

Again, you might want to contribute to both if you have ample funds, first to an IRA or 401(k) until you meet the contribution limits, then give the rest of your available money to an LIRP.