What is a life insurance retirement plan (LIRP)?
When exploring different types of life insurance, you may have heard of a LIRP, but what exactly does this policy type entail? A life insurance retirement plan—or a LIRP—is a type of permanent life insurance that uses the policy’s cash value to supplement your retirement savings. While the most common incentive to purchase life insurance is to make sure your loved ones are financially supported if you pass away, a LIRP offers the additional benefit of being a retirement planning asset. Let’s walk through the benefits of a life insurance retirement plan to help you decide if this coverage is right for you.
Understanding How LIRPs Work
A life insurance retirement plan (LIRP) is a type of permanent life insurance or whole life insurance that can be used to supplement other retirement investments. The policyholder pays their premiums, often overpaying in order to grow the account, and the policy accumulates a cash value. You can then withdraw or borrow against the cash value of the policy to provide income in retirement that isn’t subject to taxes. For seniors with fixed incomes, this can help lower your tax burden and help maintain your standard of living.
Pros and Cons of a LIRP
When considering whether a LIRP is right for you, it’s important to be aware of both the advantages and disadvantages of this type of policy.
Advantages of a LIRP | Disadvantages of a LIRP |
Tax Advantages: The cash value within a LIRP grows tax-deferred, meaning you won’t pay taxes on the gains until you make withdrawals in retirement. The cash value of a LIRP may also be accessed through tax-free withdrawals, with some exceptions. | Higher Costs: LIRPs may be more expensive than traditional retirement plans, like a 401(k) or IRA. |
Life Insurance Coverage: Your loved ones will be protected through the policy’s death benefit. | Reduced Death Benefit: Withdrawing from the cash value of a LIRP will reduce the death benefit available for your beneficiaries. |
Estate Planning: LIRPs can be used as part of your estate planning to help ensure a smooth allocation of your assets. | Lower Returns: While LIRPs offer tax-deferred growth, their investment returns are often modest compared to other investment vehicles like stocks or mutual funds. |
Flexible Payments: LIRPs may allow you to adjust your premium payments based on your financial circumstances. For example, you could reduce your premiums during periods of financial difficulty, or even use the policy’s cash value to cover your premiums. | Works Best Supplementally: LIRPs should not be the sole or primary retirement savings vehicle for most individuals. They are generally more suitable as a supplemental strategy for high-income earners who have already maximized contributions to traditional retirement accounts like 401(k)s and IRAs. |
Types of LIRPS
Because LIRPs are a type of permanent life insurance policy, you’ll want to familiarize yourself with this type of coverage if you’re considering whether a LIRP is right for you. Read on to learn more about the different types of permanent life insurance:
Whole Life Insurance: Like other types of permanent life insurance, whole life insurance features a guaranteed death benefit and a cash value component that grows on a tax-deferred basis over time. However, unlike other types of permanent life insurance, whole life insurance offers fixed premiums, meaning you’ll pay the same amount for the life of your policy.
Universal Life Insurance: Universal life insurance is a type of permanent life insurance that offers lifelong coverage and a cash value component, similar to whole life. Unlike whole life insurance, universal life insurance offers flexible premiums, meaning policyholders can adjust their premium payments based on their financial situation. Additionally, the cash value of universal life insurance is tied to market performance rather than accumulating at a fixed rate.
Variable Life Insurance: The distinguishing feature of variable life insurance is that the cash value is invested in various sub-accounts, typically resembling mutual funds, chosen by the policyholder. This allows for potentially higher growth if the investments perform well, but it also carries investment risk, meaning the cash value can decrease if the underlying investments perform poorly.
Comparing LIRP to Other Retirement Options
Life insurance retirement plans work best when used supplementally, as they’re not as robust as traditional options like a 401(k) or IRA. Learn more about the differences between LIRPs and traditional retirement accounts below.
LIRP vs. 401(k)
A LIRP uses a permanent life insurance policy to accumulate tax-deferred cash value, offering tax-free access to funds and no IRS contribution limits. A 401(k), on the other hand, is an employer-sponsored retirement plan with tax-deferred growth or tax-free withdrawals in retirement, subject to annual contribution limits. While 401(k)s often benefit from employer matching and market-driven growth, LIRPs provide a death benefit and penalty-free early access to cash, though they typically have higher fees and potentially lower returns.
LIRP vs. Traditional IRA
A traditional IRA is a dedicated retirement account that allows pre-tax contributions to grow tax-deferred, but withdrawals in retirement are generally taxed as ordinary income. While IRAs have annual contribution limits set by the IRS, LIRPs do not have such limits. LIRPs also provide a death benefit, which IRAs do not, and can offer penalty-free access to funds before age 59 1/2.
Who needs a life insurance retirement plan?
Whether or not a life insurance retirement plan is right for you will depend on your unique circumstances and financial goals. Overall, life insurance retirement plans may be most beneficial for people with specific financial situations or who prefer the long-term security of permanent life insurance coverage. This may include:
High-income earners who have maxed out other retirement accounts and are seeking an additional avenue for tax-deferred savings.
Individuals with lifelong dependents, such as family members with disabilities.
Many people won’t need life insurance by the time they retire, as many of their financial obligations, like a mortgage or a child’s education, will likely be paid off or decreased. A LIRP does have some benefits to these individuals, though. LIRPs can be used to offset income tax burdens in retirement because borrowing against them after they’ve matured or have an appropriate cash value isn’t counted as taxable income. This differs from a 401(k), where withdrawn funds are counted as taxable income. In addition, the cash value of a LIRP can be used to preserve a person’s estate when they die. Withdrawn funds can be used to pay estate taxes. For high earners or people with a significant estate, this can significantly reduce the taxes owed.
Cost of Investing in a Life Insurance Retirement Plan
There are financial considerations to keep in mind when deciding whether or not to enroll in a life insurance retirement plan. If you do choose a life insurance retirement plan, it’s wise to pay more than the required premium payment each month. This way, you overfund the cash value, and the extra money you’re contributing can grow tax-deferred. Before you commit to this policy type, make sure your budget allows for you to overcontribute to your premiums in order to make the most of the cash value’s growth.
Learn More About Life Insurance Retirement Plans with SelectQuote
Wondering whether a life insurance retirement plan is right for you? SelectQuote can help. We have over 40 years of experience helping people like you make decisions about life insurance. We’ll take the time to learn about your coverage needs, then search a variety of trusted life insurance carriers on your behalf in just minutes.
FAQs About LIRPs
Are LIRPs a good investment?
A life insurance retirement plan may not be the best fit for your financial needs, but there are some instances where it makes sense. Individuals with high net worth or significant income who are maxing out their other retirement investments may appreciate the flexibility a LIRP offers. Otherwise, the increased premiums may not be worth the investment. In these cases, buying a term life insurance policy and investing the additional funds might make more financial sense.
How much can you put in a LIRP?
One of the significant characteristics of a LIRP is that, unlike traditional retirement accounts like 401(k)s or IRAs, there are no specific IRS annual contribution limits. This means you can potentially contribute a substantial amount of money to a LIRP, making it attractive for high-income earners who have already maximized their contributions to other retirement accounts. However, it’s important to avoid overfunding the policy to the point where it becomes classified as a Modified Endowment Contract (MEC). If this happens, the LIRP loses some of its tax advantages, and withdrawals from the plan may be subject to certain penalties.
Is there a disadvantage to using a LIRP?
The primary drawbacks of LIRPs include the high costs and fees associated with the underlying permanent life insurance policy and potentially lower returns compared to other investment vehicles. Additionally, LIRPs require a long-term commitment to maintain the policy, and surrendering it early can result in significant charges. Because of this, LIRPs are generally not recommended as a primary retirement vehicle.
