Life insurance retirement plans (LIRP) are one method for building capital to support you after you quit working. These plans use specific types of life insurance policies to augment more traditional forms of retirement savings, like IRAs. In the right circumstances, LIRPs can help fill in the gaps in other retirement plans. Some of this augmentation has to do with LIRPs having fewer restrictions than alternatives, while offering different options for utilizing the plan. Because LIRPS are life insurance plans, first and foremost, they operate under different rules than other retirement strategies.

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Life insurance retirement plans explained

A life insurance retirement plan is a permanent or cash value life insurance policy funded over time to build up a substantial cash value by the time you retire. Unlike term life policies, permanent life insurance policies don’t have a preset duration, and last as long as you make the payments. LIRPs can provide retirement savers with a supplemental source of income on top of their individual retirement account (IRA) and retirement plan distributions after they stop working.

LIRPs lack some tax advantages that IRAs and qualified plans can provide, but they offer a few benefits that they cannot match. For example, there is no age requirement for certain types of distributions from a LIRP. IRAs and qualified plans will penalize you for any distributions taken before age 59 ½, barring exceptions. Furthermore, LIRPs can often guarantee the investor’s principal and interest unless the investor is contributing to a variable universal life insurance policy.

That guarantee, for those policies it applies to, means that the insurer has promised a minimum interest rate and that your cash value is protected against loss. Conversely, variable universal life insurance plans have non-guaranteed interest rates that fluctuate with underlying assets and the market. In simple terms, one protects against loss while the other offers potentially higher gains but does not protect against loss.

How to fund retirement with a LIRP

Funding a life insurance retirement plan is straightforward, but you might want to consider working with a certified financial planner or a licensed insurance professional  to ensure you are getting what you need. It just requires taking out a cash value life insurance policy for the coverage amount you want, then overfunding it by paying more than the minimum required premiums. The excess amount will go into the policy’s cash value and start building it up faster than it would otherwise. Even when you don’t overpay on these policies, a portion of your regular payment still contributes to building cash value within your policy.

That is one of the simplest forms of retirement saving, as there are very few rules that dictate the process. If you want your policy to grow faster over time, consider investing in a variable universal life policy that invests its cash value in the financial markets. There is more risk with this type of policy, but also more potential reward. Or you could invest in an indexed universal life policy, where you can make money when the financial indices rise but not lose anything when they fall. It all depends on your risk tolerance and time horizon.

When you retire, you can take tax-free distributions from your accumulated cash value in the form of policy loans. However, if your loans exceed the amount you’ve paid into the cash value portion, that excess amount can be taxed, and it will also lower your available death benefit. Of course, it is also possible to take tax-free distributions from your Roth IRA if you have one, but the Roth doesn’t offer death benefit protection and limits how much you can put in it each year. One additional note of caution is that, if you contribute too much, too quickly, the IRS could change your policy into a modified endowment contract (MEC), and the tax implications will change.

Who needs a life insurance retirement plan?

The majority of the time, there are three main situations where a LIRP can be appropriate for retirement savers:

  • High-income earners who are contributing as much to their traditional retirement savings vehicles such as IRAs and 401(k)s as possible, and are looking for additional avenues with which to save for retirement.
  • Families with special needs children who must always be cared for. In this scenario, the death benefit will provide the funds necessary to support the children upon the death of the insured.
  • Individuals with large financial goals for their retirement may find LIRPs to be an effective way to build a broader retirement savings base by branching into these plans on top of traditional retirement savings plans. Because LIRPs use life insurance as the investment vehicle, the IRS doesn’t set a maximum contribution amount for them.

Here are the primary advantages and drawbacks to consider with a life insurance retirement plan:

Pros Cons
Tax-free distributions Non-deductible contributions
Tax-free death benefit Higher cost
Guaranteed interest rate (whole life policies only) Interest rate may be low
Growth potential (universal, indexed and variable policies Limited investment choices, possible loss of principal (variable universal policies only)
Accelerated benefit riders May never be needed
Provisions for special needs children, estate taxes Additional cost

Frequently asked questions

    • The best policies for a LIRP will depend on your circumstances, goals, timeline and provider. Some types of permanent life insurance offer a higher potential for gains, but include fewer protections against losses. Other types can offer increased protections, but may have lower upside potential. Generally, forms of universal life insurance have fewer protections and greater gains potential, while whole life insurance policies offer the inverse. You should consider discussing your goals with a certified financial planner or your insurance agent to determine what the right path is for you.
    • LIRPs evolved out of cash value life insurance policies and have been used since these types of insurance plans first became commercially available. As the life insurance industry has grown and expanded, more cash value policy types have been created. With the advent of some of these newer types of permanent life insurance, the use of LIRPs has become more popular. In part, this is because some of these newer types allow for quicker cash value accumulation in the right circumstances.
    • There are a couple of ways to approach canceling your permanent life insurance policy, both with different outcomes. The simplest approach is to surrender your policy to the insurer. This method results in being paid the cash value of your policy, minus any fees. The other option is to sell your policy on the market. If successful, this will transfer full ownership of the policy to the buyer, for whatever price is agreed upon. Some insurers may help sell your policy if you choose this route, but that is not always the case. In both cases, you lose access to the policy and its benefits or payouts afterward. Consult with your certified financial planner of insurance agent to learn more about your options.