Look Before You LIRP
Why All Life Insurance Retirement Plans are Not Created Equal, and How to Find the Right One for You by David McKnight
Look Before You LIRP is an important follow-up guide for those who read David McKnight’s previous book The Power of Zero and for anyone who wants to learn more about Life Insurance Retirement Plans (LIRP).
In The Power of Zero, David makes a great argument for retirement planners to prepare for the inevitable rise in taxes and delivers a step-by-step strategy for accumulating wealth without tax-liability during retirement.
A point that should really stick with the reader is that tax increases will not affect those who have implemented a 0% tax retirement plan. If taxes double in the future, two times zero or even three times zero equals zero.
If you have read The Power of Zero then you should be legitimately convinced that the 0% tax bracket is readily available and that the best method to get you there is by using a LIRP as a foundation for your retirement strategy.
David goes on to say (in the beginning of Look Before You LIRP) that the best insurance product to use is Indexed Universal Life and this book provides the “why, who, and how” for going forward.
Chapter 1 – Finding the Right LIRP
David uses chapter one to lay out his argument that it is virtually impossible to get to the 0% tax bracket without using a LIRP. He offers the math that shows if your retirement plan is taxable and taxes go up in the future (count on it), every retiree with a taxable retirement plan stands to lose about a third of their wealth to the IRS when they will need it the most.
There are six solid reasons why a LIRP is the only way to get to 0% and David lays them out from the beginning:
- No Withdrawal Penalties – If an account holder wishes to withdraw funds from a LIRP before age 59 ½ there are no penalties like you’ll find in a 401(k) or IRA.
- There are no 1099 Forms – Since the money that is accumulating within your LIRP isn’t taxable, you will not be taxed like you would with a CD or mutual fund. This represents significant savings over the course of your retirement.
- Distributions (withdrawals) are not Reported as Income or Provisional Income – When an account holder withdraws funds from their LIRP the right way, it is not reportable income which means the withdrawals are tax-free and not considered provisional income either. Your social security benefits will not be affected by your LIRP withdrawals.
- No Limits on Contributions – Unlike traditional tax-deferred retirement plans, there is no limit on the amount of contributions you can add to your LIRP. The only stipulation is that the amount of your contributions are tied to the death benefit you select.
- No Limit on Annual Income – Unlike a Roth IRA which caps the amount you may contribute based on your income, there are no income limits with your LIRP.
- No Legislative Risks – Although a tax-hungry legislature has changed the rules on LIRPs periodically in the past, each time they grandfathered in LIRPS that were already in place.
Certainly, many readers may have already decided that a LIRP is the final answer to retirement planning because of the rules listed above and to these folks David recommends considering a LIRP as one of many tools available to help you achieve a 0% tax bracket in retirement.
In fact, in the latter part of this chapter David lays out the guidelines you’ll need to consider when deciding on the “perfect” LIRP. He recommends that the reader compare purchasing their LIRP to getting married; hence Look Before You LIRP. Mr. McKnight goes even further by providing characteristic suggestions that you should consider before saying “I do” and designates a chapter for each of them. Here is what you should look for in an Indexed Universal Life policy:
- Safe and Productive Growth
- Low Fees
- Tax-free and Cost-free Distributions
- Cost-Free Long-Term Care Rider
Chapter 2 – Safe and Productive
Certainly, every investor wants their contributions to be safe and immune to possible losses, but most understand that they will also need their LIRP to be productive. Some consider this an oxymoron but we’ll explain why it really isn’t.
David lays out a very good argument (using math) why the Indexed Universal Life policy is the only product that can be safe and productive. These plans are set up to allow the account holder to invest in various indices so that stock-type earnings can be achieved but the plan will also prevent the account holder from losing money in a down market. You are literally investing in the market without being in the market.
The insurance company allows you to earn interest based on the performance of the index or indices you choose up to a limit. This limit is called a “Cap.” For example, if the cap in your policy is 13% and you indices have earned 16%, your account would be credited 13% (the cap).
But, and this is an important “but”, your policy will also have a “floor” which represents the minimum your account will earn. For example, if your indices have a loss of 4% and your floor rate is 0%, your account will not lose money for the reporting period. The floor and the cap represent the safe and productive characteristics of your Indexed Universal Life policy (IUL) in your LIRP.
In the balance of this chapter, David really drills down to illustrate and explain how the cap and floor rate in the IUL policy allows for the account holder to earn significant gains in the market while at the same time protecting the account holder in a volatile market.
He offers the following table that shows what happens to a $1,000,000 investment over 15 years and compares a straight investment into the S&P 500 with an IUL investment with a 14% Can and a 0% Floor.
|Year||S&P 500 % Returns||S&P 500 $1 mil||IUL $1 mil||Floor 0%|
|Rate of Return||2.95%||7.07%|
Chapter 3 – Low Fees
All investment products contain fees. Fees represent lost income that can never be recovered so it’s important that you understand them from the start. When David discusses fees charged in an IUL, he represents that the fees are low if you compare them to other investment products.
For example, if you are earning high rates of return in your IUL but paying exorbitant fees, the justification for purchasing the IUL will be significantly diminished. But when you are earning a high rate of return and with low fees, you’ve certainly picked the LIRP that will deliver significant income during retirement.
In this chapter, David goes on to explain how you can compare the fees you’ll pay for an IUL compared to other tax-free investment products. He explains what we consider logical but most first time buyers may not. That is that you must compare the fees you’ll be charged over the long-term and whether the fees are calculated based on the funds in the investment like a Roth IRA rather than the death benefit in your IUL (remember, there is a death benefit).
Suffice it to say that Mr. McKnight offers several pages of illustrations (math) showing that over time the fees charged in your IUL policy will be lower than most traditional investment products.
Chapter 4 – Tax-Free and Cost-Free Distributions
In chapter 4 Mr. McKnight talks about how your safe and productive LIRP could be neutralized without the ability to take tax-free and cost-free distributions. We know that all LIRPs on the market today allow for taking tax-free distributions but what’s not certain is if the IUL you choose offers cost-free distributions. Make you sure your insurance professional knows that you know taking money out of your account must be cost-free as well.
How are distributions tax-free and cost-free?
If you elect to take a distribution from your LIRP, in the same manner, you would take a distribution from your IRA or 401(k), it will be a taxable event since the money is considered taxable income. If, however, you take your money out the correct way, which is a loan, the IRS would not consider the money income rather, they would consider it a tax-free loan. Here’s how it works:
- You contact the company and tell them you want a policy loan for $10,000 (or any other amount)
- The company takes the $10,000 from the growth account and deposit it into a collateral account where it continues to earn interest.
- Simultaneously, the company takes $10,000 from their account and sends you a check.
- The insurer is going to charge you interest since they are lending you their money.
- When you die, the money in your loan collateral account will be used to pay off your outstanding loans. If the interest in your collateral account is the same or higher than the interest on the company loans, you’ll break even and end up with a zero net cost of loans over your lifetime.
What if something goes wrong?
If you’re not paying close attention, things could possibly go south. For example, if the insurer promises to pay 3% interest on your collateral account but reserves the right to charge you more than 3% on your loans, you could end up paying more interest out than what your earning which could have a significant impact on your LIRP. Unless you pay the difference in interest earned versus interest charged, your policy could end up going bankrupt which results in your loans becoming taxable.
In the rest of this chapter, Mr. McKnight provides a loan analysis (the math) to illustrate the pitfalls of purchasing your IUL from a company that has a lot of wiggle room when it comes to the interest they can charge for policy loans. The answer here is relatively simple, don’t do business with a company that has the option of charging more interest than what they are willing to pay on your collateral account.
This is when an experienced and reputable insurance professional will be your advocate. Make sure your insurance professional is familiar with the LIRP and understands the pitfalls that could impact your IUL policy.
Chapter 5 – Long-Term Care Rider
This is a chapter that we consider to be one of the most important in David McKnight’s book about the LIRP. You see, more people do not consider the financial consequences of long-term health care than those that do. Here are two eye-opening facts to consider about long-term care:
- The most recent statistics reveal that there is a 70% chance that at least one spouse will experience a health event that will require long-term health care.
- The expense of a long-term care event can easily consume a lifetime of savings and leave the community spouse and their heirs financially devastated.
Knowing that the chances are so high of losing your retirement savings to a long-term care event makes it a high priority to mitigate this risk. The traditional manner for mitigating the risk of long-term care expenses is to self-insure by creating a nest-egg to pay for these expenses or rely on family members if the worst should happen or purchase a traditional long-term care insurance policy.
The argument that David offers for each of these choices makes it clear that an alternative method is would be a wiser choice. The alternative method that he favors most is a Long-Term care insurance rider on your Indexed Universal Life policy, and the kind that you’ll not have to pay an additional premium for the rider. Here’s how it works:
Most insurers that offer this rider will agree to pay 2% of the death benefit over 4 years but they’ll want to discount that amount. For example, if you have a $400,000 death benefit but need to spend it on long-term care expenses, you would be entitled to 2% of the death benefit or $8,000 a month for four years. The issue here is that the payment will be discounted based on your age before the check is cut. Most companies will convert your age to a percentage, such a 75-years-old being 75%. This means that instead of getting $8,000 per month for 4 years, you would receive $6,000 a month instead.
With this option (rather than buying a long-term care rider) you would receive less money for long-term care expenses, but if you died in your sleep rather than being in a nursing home, your beneficiary receives the death benefit plus the cash account and you save the cost of the rider for all of those years.
Be sure and discuss your long-term care insurance options with your insurance professional and make sure that he or she represents a company that offers a free long-term care rider.
In the final two chapters, David discusses steps for planning to locate the best IUL for your LIRP. There are many out there so just like buying a car, you’ll want to locate the one with all the options you require.
Mr. McKnight also discusses the myths you will like find when you do internet searches about LIRPs and the misinformation that is out there because retirement professionals will generally only write good things about the product they represent and believe in the most.
Be sure to read our book review for The Volatility Shield.