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There are many potential approaches to saving for retirement, and navigating your options may seem daunting. Life insurance retirement plans (LIRPs) may be one way to build capital to support you after you quit working. LIRPs use specific types of life insurance to augment more traditional forms of retirement savings, like IRAs. Bankrate’s insurance editorial team breaks down what a LIRP strategy might look like and how it may help you save for retirement.
What are life insurance retirement plans?
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 are designed to last for your entire lifetime, and last as long as you make the payments. LIRPs may 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 standard plans 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.
For those policies it applies to, that guarantee 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 use life insurance in your retirement planning
Funding a life insurance retirement plan is fairly straightforward, but you might want to consider working with a certified financial planner or a licensed insurance professional to ensure you are on the right track. Here are a few ways you might use life insurance in your retirement planning:
- Research cash value life insurance policies: After choosing a type of permanent life policy that suits you, you may want to start paying more than the minimum required premiums on the cash value life insurance policy. This helps you accumulate funds as the excess amount will go into the policy’s cash value and start building it up faster than it would otherwise. Even if you don’t overpay on the policy, a portion of your regular payment will still contribute to building cash value within your policy.
- Consider a variable universal life policy: A variable universal life policy allows you to invest the cash value in the financial markets. Although there is more risk with this type of policy, the rewards can be high as you make money when the financial indices rise.
- Take tax-free distributions: When you retire, you can take tax-free distributions from your policy’s 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. 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.
LIRPs may be an appealing way to supplement traditional retirement accounts. 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. Speaking with a licensed financial planner or insurance agent may help you achieve your financial goals without experiencing unwanted tax surprises.
Is a life insurance retirement plan right for me?
The majority of the time, there are three main situations where a LIRP might 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 disabled or dependent 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.
Pros and cons of LIRPs
Here are the primary potential advantages and drawbacks to consider with a life insurance retirement plan:
|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 be available||May never be needed if traditional retirement accounts offer enough funds|
|Provisions for disabled children, estate taxes|
How much do LIRPs cost?
The cost of an LIRP and amount of money you put into it can vary depending on your financial situation, circumstances and retirement goals. Your premium may determine how much extra money you will put into your LIRP, and your premium is dictated by personal rating factors like your age and health status. Your chosen policy type and riders will also impact your premium. Typically, life insurance policies are cheaper for younger individuals and those in good health. Policies with lower death benefits also typically see lower premiums.
Depending on your goals for your LIRP, you may choose to adjust your coverage amount and contributions. For example, if you do not have much need for life insurance, but you want to use an LIRP as a vehicle for retirement funds, you might choose a policy with a lower coverage level that might have a lower premium. This may allow you to use extra funds to build your cash value component for more robust retirement funds, but your beneficiaries will receive a smaller death benefit when you pass away.
LIRPs are typically not designed to be used as a sole retirement planning vehicle. These plans are typically used in conjunction with traditional retirement plans, like IRAs and 401(k)s, to supplement retirement funds with a flexible cash value component. Speaking with a licensed financial professional may be the best way to determine if an LIRP could advance your retirement goals.
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 a lower potential for gains. Generally, forms of universal life insurance have fewer protections and greater gains potential, while whole life insurance policies offer the inverse. You may want to consider discussing your goals with a certified financial planner or your insurance agent to determine what the right path is for you.
A LIRP uses the cash value component of permanent life insurance plans to potentially build more robust retirement funds. Any company that offers permanent life insurance may have a policy that you can use as a LIRP.
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.
Whether a life insurance policy is a good addition to your retirement planning strategy entirely depends on your personal financial situation and retirement goals. If you know you want some form of permanent life insurance, the cash value component may be an added benefit for your retirement planning. However, LIRPs are typically used in conjunction with traditional retirement plans to diversify your retirement strategy. One of the potential benefits of LIRPs is that the cash value component is fairly flexible and may be used for whatever you choose. The policy also does not limit cash value use based on age, like many other retirement products, so even if you want to use the cash value before your retirement, you likely have the flexibility to do so.