A LIRP is a life insurance retirement plan that provides you with the tax-free advantages of a Roth IRA without all of the hassles. As Americans watch the national debt spiral further out of control, there’s a growing sense of dread. In fact, as of May 2019, our nation has gone from a budget surplus to being over $22 trillion in debt.
As a result of government spending, many U.S. Americans are turning to tax-free accumulation tools as way to protect their assets for retirement from the impact due to rising taxes, inflation in the economy and investment risk in the stock market. For many future retirees, a well-designed tax-free retirement planning tool might include utilizing a LIRP, or life insurance retirement plan.
In the past we have seen whole life insurance, variable universal life insurance and current assumption universal life insurance used as LIRP vehicles. Our recommendation is to use an indexed universal life insurance policy from a company with quality products that are structured properly to minimize expenses and maximize cash value and tax-free income.
A LIRP is not a one size fits all solution to retirement. We have a LIRP calculator that can help in providing future tax-free income projections. We have a LIRP fact finder or questionnaire that allows us to learn more about your goals. We can then build a LIRP around those goals.
Since a LIRP is a life insurance policy there are expenses to consider. We build your policy with as little life insurance as possible. We base your death benefit on the amount of your contributions. When we know how much you want to save in your LIRP, we can solve for the minimum amount of death benefit we have to buy in order to keep your LIRP income tax free.
We have reviewed the top indexed universal life insurance companies and the following are ones we feel are worthy to use for your LIRP:
- North American
- Midland National
- Allianz Life
- Columbus Life
- Minnesota Life
- American National
- American General (AIG)
LIRP Advantages and Disadvantages [Pros and Cons]
A LIRP is a life insurance policy that incorporates many of the tax-free features of the traditional retirement accounts, like a Roth IRA. Cash grows income tax free inside your policy during the contribution years and income is taken income tax free through policy loans. In addition to the distributions being completely tax-free, these distributions do not increase your taxation of Social Security.
No income thresholds to be concerned about
When it comes to a Roth IRA, there are limits on the amount of income that can be contributed. For 2019, for example, high income earners who are married and filing jointly, can’t contribute any of their income to a Roth IRA if their combined taxable income exceeds $203,000. If you are eligible to contribute to a Roth IRA, you are limited to a contribution amount of $6,000 or if you are age 50 you can contribute $7,000. The deadline to make your Roth IRA contribution for 2019 is April 15, 2020.
You may also find yourself limited in what you want to contribute to a 401k or IRA. The same limits apply to a traditional IRA as they do with a Roth. The maximum IRA contribution for 2019 is $6,000 or if you are 50 or older by the end of the year it is $7,000.
The LIRP has no such limitations and can offer the flexibility needed to shift around highly taxable assets into a tax-free account.
Depending on the amount you would like to contribute to your retirement savings, a life insurance retirement plan or LIRP might be the answer.
No contribution limits like a 401k or IRA
The 401(k) limits for 2019 are $19,000 and SIMPLE 401(k) deferral limit is $13,000. Many of our LIRP clients max out IRA and 401(k) plans before contributing to their LIRP. We only recommend this for high income earners that are in the top tax brackets. It just doesn’t make sense to defer taxes now if you will be in the same or higher tax bracket at retirement.
Little or no risk of government control
These large amounts of cash that are sitting in individuals life insurance policies have always been a target for government. These accounts are full of cash that will continue to grow income tax free, distribute tax free income and at death, pass income tax free to your family. However, as has been noted on the side of history, the LIRP has be resistant to the impact of any such changes to tax law. In fact, when Congress adjusted the rules on LIRP policies in the 1980s, those LIRP policies already in existence were continued to be taxed under the pre-existing laws (grandfathered clauses).
Index Options available
The LIRP offers the flexibility of choosing how exactly to allocate and grow funds within the tax-free cash value accumulation account. The S&P 500 is the most common indexed used in these policies, however policyholders have the choice among many indexing strategies to choose from. You can also change from one or more indexing option to another and also have access to a fixed account earning a guaranteed amount of interest. Your risk strategy will change throughout the life of your LIRP so make sure that you choose a policy that is flexible.
Depending on the type of life insurance policy you choose, you will have the following options. As mentioned earlier, you can use whole life, variable universal life, current assumption universal life and indexed universal life insurance.
- Stock Market (Variable Life)- Policyholders can deposit their contributions into mutual fund portfolios, known as sub-accounts by the insurance company they’ve chosen. Even though this method may provide more substantial returns, it does put the policyholder at risk if the market severely declines. Some consumers stay away from this approach due to the economic collapse experienced in 2008.
- Index (indexed UL) The accumulated cash value associated with this strategy is tied to the upward performance of a specified stock market index, such as S&P 500. Participation in growth on behalf of contributors can occur up until the cap of 13-15%. Conversely, if the stock market index performs negatively, the accumulation account is credited 0%. This is a safe, but manageable way to grow your tax-free money for retirement.
- Insurance Company Investment Portfolio (whole life or current assumption ul) Policyholders also have the opportunity to accumulate their cash value within the selected insurance company’s investment portfolio. Since insurance companies do largely manage risk, the return of these types of arrangements are usually safe, although modest. The average return of these types of policies ranges between 3 and 5%.
Life insurance has expenses
A life insurance retirement plan (LIRP) sounds like a problem-free retirement tool, but it’s not a one-size-fits-all recommendation for tax-free growth. A qualified insurance professional is going to recommend that you diversify your streams of eligible tax-free income.
In order to keep the definition of life insurance, you will need to have your policy structured properly. You will need to maintain a minimal amount of life insurance and this amount is based on the amount of contribution you want to make. We strongly encourage that there is a need for life insurance before deciding on a LIRP. This is life insurance after all. You may not see a huge need for additional life insurance but when you weigh all of the benefits, you can make your decision.
Most of the indexed universal life insurance policies that we see today offer an accelerated death benefit. This will allow you to access the death benefit with out having to die. The death benefit can be accelerated in the event of a terminal illness, critical illness or chronic illness. This makes for a great alternative to purchasing a long-term care policy.
If a policyholder doesn’t need to access the accelerated benefits available, then the tax-free death benefit will be distributed to your beneficiary at the time of your death. This is a lot cheaper than paying premiums for long-term care insurance that you might never use.
Keep in mind, however, that unless the LIRP is designed appropriately, the expenses associated with the policy can overpower the growth made within the accumulation account. In order to fully maximize the advantages of the LIRP strategy, you will want to buy the minimum amount of insurance required while investing the maximum amount possible according to IRS guidelines.
LIRP Closing Thoughts
As we said earlier, when choosing life insurance to serve as a retirement income tool, there are a few key points that you’ll want to consider. A LIRP is a long term play. You will typically need at least 10 years for your accumulation period, but we have set some LIRPs up with shorter time frames. The more time you have the better. You will need to make sure the policy is structured to maximize the growth and minimize expenses. You will fail if you allow your policy to become a modified endowment contract or MEC. A MEC is a life insurance policy that has too little death benefit to support the premiums being paid. Most companies will send back funds to the policy owner in excess of the maximum allowed keeping them safe from becoming a MEC.
If a policy is found to be a MEC, the policy will not fall under the favorable income tax treatment of the LIRP because the IRS will deem it as too “cash value rich”. Remember, not all cash value life insurance policies are identical. We can advise you throughout the LIRP process. You have to consider what carrier will work best for your situation and this will all depend on your personal funding level, health status and future needs and goals.
IUL can be a great retirement planning vehicle for most age groups. Many of our clients today are finding that their old traditional 401k or IRA accounts are a huge tax liability and are considering IRA to ROTH conversions. While this is not recommended for everyone, an IRA conversion may be ideal for our clients age 59 1/2 and older. Being over 59 1/2 is the age where the 10% IRS penalty for early withdrawal goes away. By paying the tax on the converted funds now, an IRA holder can possibly eliminate hundreds of thousands of taxes over their lifetime.