A life insurance retirement plan (LIRP) is a policy with a cash value feature that you can treat as an investment, and fund over time. Through it, you can build up a substantial amount of money by the time you retire. You can then borrow that money to supplement your income from any other retirement savings plans you have, such as a 401(k) or a Roth IRA, and your Social Security payments.
LIRPs offer several advantages and drawbacks, and they aren’t necessarily a good investment choice for everybody. But if you fit the profile, understand how they work, and have certain financial goals, a LIRP may be a smart addition to your portfolio.
What is a life insurance retirement plan?
A LIRP adds value to your life insurance policy. It turns your insurance into a vehicle both for retirement savings, and to ensure your family will have financial security after your death.
In its simplest definition, a LIRP is any life insurance policy with a cash value feature — such as a whole life or universal life policy.
Cash value means the policy includes an investment component. Part of the premium you pay goes toward the actual life insurance, while the other portion goes toward building up cash value. Your insurance company invests the cash, and rewards you financially in the form of tax-deferred interest. You can then access this cash through a loan against the policy after you retire (you can also surrender [cancel] the policy to access this cash, or use the cash to help pay your premiums).
With a LIRP, therefore, the policy’s cash value is a source of retirement income. As you pay your premiums during your working years, and the tax-deferred interest grows, you build up a nest egg of cash.
How a life insurance retirement plan works
To get started saving with a LIRP, you simply purchase a cash value policy from a life insurance company. Choose an amount that meets your family’s insurance needs, then overfund the policy by paying the insurer more than the minimally required premiums. The amount of money you pay in excess of the premium will fund the policy’s cash value.
As is typically the case with investing, there may be some risk. It mostly depends on the type of policy you choose.
For a more aggressive LIRP investment, choose a variable universal life policy. Your money will be invested in financial markets, offering both greater risk and reward — you could actually lose money in down years for the market, but stand to earn more in strong years. For a more conservative approach, consider an indexed universal life policy. With this option, your potential earnings are more limited, but your risk of losing money when the markets fall is also minimized.
Once you’re retired, you can take tax-free distributions from your cash value policy in the form of policy loans (which must be repaid). These loans can be an important supplement to your other retirement savings accounts, for reasons explained next.
LIRP advantages and disadvantages
An LIRP offers several advantages and disadvantages as a retirement savings tool.
- A LIRP can offer additional flexibility when it comes to your retirement portfolio. If you’ve maxed out your annual contributions to your IRA or 401(k), but still have more you’d like to invest tax-deferred, you can channel that money into your LIRP.
- There are no age restrictions on accessing your cash value. This is unlike an IRA or 401(k), which charge penalties for making withdrawals before age 59-1/2.
- Once you’ve retired and have started living off your retirement account funds, it may be advantageous to shift your income to flow more from your LIRP than from your IRA during down years for the stock market.
- Depending on the type of cash value policy you buy, your LIRP may guarantee a minimum return.
- Unlike an IRA or a 401(k), a LIRP offers a death benefit.
- Your LIRP’s distributions are tax free, as is its death benefit.
- The tax-deferred nature of your LIRP income will also lower your provisional income, which is used to calculate tax on your Social Security payments. The result is that less of your Social Security will be taxed.
- Cash value insurance policies (such as whole life and universal life) are very expensive; it may be difficult to maintain the premium payments.
- LIRPs offer limited investment choices, and 401(k) and IRA accounts generally have much better financial returns.
- Any money you access through a loan against the policy will accrue interest. If you die before the loan is repaid, the balance will be deducted from your death benefit.
Who can benefit from a LIRP?
As stated earlier, LIRPs aren’t right for every investor. But if you have certain needs, a LIRP may be an ideal tool to help you create financial security for you and your family.
Experts generally identify three types of people who are most likely to benefit from a LIRP.
- High income earners. If you typically max out the contributions you’re allowed to make into your IRA or 401(k), then a LIRP would be something to consider for additional tax-deferred savings.
- Retirees with lifelong dependents. If you have children with disabilities, or other dependents who rely on you financially, a LIRP can help provide both the retirement income you’ll want and the security your family will need after your death.
- High net-worth individuals with estate tax concerns. As the policy’s death benefit can be used to pay taxes related to your estate, a LIRP may be appealing.
Is a life insurance retirement plan worth it?
If you’re not in one of the three categories of people outlined above, a LIRP may not be worth your while.
For retirement savings, you’re likely much better off to invest in a 401(k) or IRA plan. These offer higher returns, with investment options that can be customized based on your risk tolerance and time frame. Even if you do regularly max out your contributions to your tax-deferred plans, a standard post-tax investment may provide a greater rate of return.
For insurance, you may be better off exploring your options for term life. A term life policy is likely to be more affordable than a cash value policy, while providing the death benefits your family will need to stay financially secure after your passing.
A good next step would be to consult with your financial advisor. Your advisor can help you better understand these options, assess your current financial portfolio and goals, and determine if a LIRP is right for you.