There are many ways to approach retirement savings, and with these options come pros and cons. The Life Insurance Policy Plan (LIRP) is no exception and should not be discredited as a viable option for retirement savings with careful consideration by the savvy investor.
LIRPs are whole life insurance policies that use the accrued cash value of the policy for retirement expenses.
These policies function similarly to Roth IRAs in that they can be withdrawn from tax-free after age 59.5, and the accrued interest is tax-deferred.
LIRPs are only for some, as they are expensive to maintain and can result in the collapse of the policy if one is not careful.
What is a Life Insurance Retirement Plan (LIRP)?
A LIRP, or life insurance retirement plan, is a whole life insurance policy to help fund retirement. A portion of the whole life insurance policy premiums is invested into the stock market and grows in cash value. The cash value can be used to fund the insured’s retirement. The LIRP mimics the benefits of a Roth IRA in that withdrawals made after the insured turns 59.5 years old are tax-free, and the gains made on the cash value investments are tax-deferred.
How does a Life Insurance Retirement Plan work?
A Life Insurance Retirement Plan functions in two ways. The insured pays more into the insurance policy than is necessary to fund the policy's death benefit. As a result, the remaining cash is invested into the stock market and builds interest. Of the two options, the insured can either take out a loan against the amount of the accrued cash value or the insured can make a direct withdrawal. Both require a waiting period from when the insured initially takes out the policy, usually stated within the insurance document, and are tax-free up to the amount the insured paid into the policy, with any interest of the cash value remaining taxable until the insured turns 59.5 years.
The cost of LIRPs
Because the insured is funding both the death benefit and paying into the policy's cash value, life insurance retirement plans are an expensive form of retirement savings. Below is a table that outlines the potential cost of a LIRP for a 40-year-old male purchasing $500,000 in coverage until age 65 from a standard insurance company as an example:
|Premiums||$11,000 annually||The cost to maintain the policy. Can be paid annually at a potential discount.|
|Processing Fees||$10 monthly||Automatically withdrawn from the policy value. Covers insurance company fees.|
|Premium Load Fee||3% of coverage||Usually part of the premium cost covers the cost of the sales team commissions and costs.|
|Policy Riders||Varies||Depending on what riders are purchased for the policy, there may be additional monthly costs.|
|Surrender Charge||100% of policy at the start, decreasing over 10 to 20 years.||The cost to surrender or prematurely end the policy. The surrender charge means giving up 100% of the cash value and decreases incrementally over the next 10 to 20 years.|
|Potential Taxes||Income tax is charged for early cash value dividend withdrawal. (22% national average based on income)||Insureds must pay income tax on cash value dividends withdrawn before 59.5. Based on income brackets, the average percentage is 22%.|
Life Insurance Retirement Plan pros and cons
Like any insurance policy or retirement plan, the LIRP has pros and cons that may apply. Individuals should think critically about whether a life insurance retirement plan fits their circumstances. Some advantages and disadvantages are included below:
What are the 5 factors to consider when planning for retirement?
Within the context of a retirement plan, there are many factors to consider. For the sake of simplicity, we have included five factors to consider:
- Determine the average yearly expenses to understand better how much will be needed to fund your lifestyle. Ensure the retirement plan is growing at a rate that will cover expenses in retirement.
- Determine if the retirement plan funds can pay for such a lifestyle. Keep track of tax rules and regulations, interest rate trends, and what happens with your money.
- Consider that the risk for severe sickness and medical care increases with age. Some whole-life policies used for LIRPs contain “living benefits” that allow you to use a portion of the death benefit to fund medical expenses in certain conditions.
- Plan for dips and changes within the market. Even if a life insurance retirement plan is going well, this should never be the only means of saving for retirement.
- Make sure family members are protected in case of drastic change. Life insurance should be a vital part of anyone’s retirement planning.
How do I calculate my retirement plan?
While this number will look different for each family, there are a few standard rules to remember. Like many life insurance policies, many retirement plans assume a life expectancy of 95 years. So, if an insured plans on retiring at 60, they should plan on 35 years of expenses saved up. Then multiply this number based on your yearly expenses. A common rule of thumb is to plan on 70% of your current annual income. For example, if you are making $60,000 per year and plan on retiring at 65, you should formulate a retirement plan that allows access to roughly $1.26 million by the time you retire, accounting for interest earned. This formula shouldn’t be the only way to calculate a retirement plan. Seek a financial planner to determine a plan that is right for you.
When and why should I get a level term life insurance policy?
A level term life insurance policy is often referred to as a term life insurance policy and usually cannot be used when establishing a life insurance retirement plan, as the premiums only contribute to the death benefit of the policy. However, the level term life insurance policy is beneficial in that the premiums and death benefit amounts do not change but remain level throughout the lifetime of the policy.
A level-term life insurance policy will generally have a lower premium when insureds are younger with lower health risks. Therefore, those who are younger and looking to purchase life insurance to cover risks like lost income, home mortgages, or loans should purchase a level-term life policy to lock in a premium rate that they can enjoy for however long the policy lasts, usually in 10, 20, or 30-year increments.
Should I get a life insurance retirement plan if I already have a pension?
A LIRP is beneficial in addition to other retirement vehicles such as pensions, but usually only a good option in addition to a 401K, Roth IRA, pension, or other forms of retirement plans.
What is the best life policy for a life insurance retirement plan?
A whole life policy is necessary for a life insurance retirement plan. From there, several cash-value life insurance policies can be used. The most versatile policy for choosing where to invest cash value, potentially the most beneficial for starting a LIRP, is a Variable Life policy.
When should I start a life insurance retirement plan?
A life insurance retirement plan is best pursued when you have maxed out other retirement plans and have time to allow the policy to grow. Because the premiums are cheaper for those younger, and there is typically a waiting period until you can withdraw from the policy’s cash value, these plans are best pursued when the insured is younger.