For individuals that want to supplement their retirement plan with a non-traditional retirement account, a life insurance retirement plan (LIRP) can be an ideal solution. Life insurance retirement plans allow retirees to be in control of how much they decide to contribute since there is no cap or limit on how much money can be put into an LIRP in a year.
You can augment your retirement income with this type of strategy, but there are some drawbacks to this method. Find out how an LIRP stacks up against a 401(k) and an IRA. You can use the cash value of your whole life insurance policy — or any other type of cash value life insurance — to augment your retirement income if you have one.
LIRPs are promoted by some insurance agents as a primary benefit of cash value life insurance. However, while cash value policies can provide flexibility and tax benefits in retirement financial planning, utilizing life insurance to support retirement savings carries hazards that all life insurance customers should be aware of, especially those nearing retirement. Read on to learn if using this strategy is optimal for your retirement planning goals and how it compares to a 401(k) or individual retirement account (IRA).
What is a Life Insurance Retirement Plan?
A life insurance retirement plan is a long-term life insurance policy with a cash value component that can be used to help pay for retirement. LIRPs are similar to Roth IRAs in that you don’t pay taxes on withdrawals after the age of 59 ½, and capital gains are tax-deferred. However, LIRPs are different in that any withdrawals prior to age 59 ½ are tax-free. Any cash-valued permanent life insurance policy, such as whole life insurance or IUL, can help you save for retirement. Term life insurance has no cash value and so cannot be used to fund a life insurance retirement plan.
What is a Life Insurance Policy’s Cash Value?
The cash value of your cash value life insurance policy is a tax-deferred, investment-like savings component that receives a portion of your premium payment. Your unique policy determines the amount that goes into savings, and the cash value account grows over time.
You can obtain the money by withdrawing from it or taking out a loan against it after you’ve held the cash value for a specific amount of time, and that money can be utilized to provide tax-free income in retirement.
How Can a Life Insurance Retirement Plan Save For Retirement?
In the event of a stock market slump, LIRPs can supplement your existing retirement savings accounts and fill in the gaps. If you contribute the maximum amount to your traditional investing accounts, you can put any remaining funds into your cash value account, giving you another tax-deferred investment option. In a weak year for the stock market, it may be more advantageous to withdraw from a cash value with a fixed rate of growth rather than a depreciated retirement account.
To fund your cash value, pay more than the required premium.
Some policyholders prefer to overfund their cash value life insurance policies by paying considerably over the statutory premium each month in order to build up enough cash value to supplement retirement. The extra money customers pay goes towards the cash value of the policy, which grows tax-free. However, this technique only works provided you don’t exceed the yearly premium limit, as follows: A modified endowment contract (MEC) is created when an overfunded cash value insurance exceeds the yearly premium limit (established by the IRS), and withdrawals are subject to additional taxes and penalties.
Use the cash value to help you save for retirement.
Many financial experts advise following the “4% rule,” which states that you should withdraw no more than 4% of your money each year of your retirement. You can access the cash value of your life insurance policy as well as your retirement assets if you have a cash value life insurance policy. This enables you to plan ahead for your retirement spending. For example, if the stock market has had a bad year, you can take money from your policy’s cash value rather than your IRA, which will restore your IRA funds.
Benefits and drawbacks of a life insurance retirement plan.
A life insurance retirement plan is designed to be flexible and is perfectly suited for high-net-worth earners who have maxed out their retirement accounts. But there is no financial plan that is a perfect one-size-fits-all solution. With how LIRPs are designed, they can come with inherent restrictions and a lower return than other plans.
| Benefits of LIRP | Drawbacks of LIRP |
|---|---|
| Guaranteed death benefit when you die | Longterm high premiums |
| Borrowing from cash value is penalty free | Withdraw fees scale with coverage period length |
| No contribution limits | Lower return rate than a 401(k) or IRA |
| Guaranteed minimum | Contributions are not tax-deductible |
Differences Between a Life Insurance Retirement Plan and a 401(k)
Life insurance is not designed to replace a 401(k). Rather, it’s recommended that you reach the caps of your 401(k) before funding a LIRP.
Speculation and Guarantees
A traditional 401(k) is rigid with its investment choices and you can’t access the money without restrictions, taxes, and penalties. It’s a vehicle that speculates for gains on market trends and the return can be lucrative with wise investments. In contrast, a life insurance retirement plan does not suffer from market swings and returns come with more guarantees.
Liquidity
In the majority of cases, funds within a 401(k) can’t be accessed before you reach the age of 59 ½. If you were to access the funds sooner, most plans will charge you a penalty and the funds become taxable. A LIRP is one of the simplest ways to access liquidity because you build up the cash value of the policy (so long as it’s a policy loan).
An Asset for Your Loved Ones
A LIRP offers a death benefit to your beneficiaries and is typically tax-free. A 401(k) is intended to be used while you’re still living.
Who Needs a Life Insurance Retirement Plan?
By the time they retire, most people will no longer require life insurance. Because your financial obligations, such as paying off a mortgage or supporting dependents, typically reduce as you become older, so does your need for life insurance.
Get Started With An Life Insurance Retirement Plan
Matador Insurance can help you evaluate your options in just minutes, whether you’re interested in learning more about life insurance retirement plans or determining what kind of coverage is suitable for you. Contact us online or request a consultation to address any questions or concerns you may have about a life insurance retirement plan today.