Life Insurance Retirement Plan
What Is an LIRP?
A life insurance retirement plan is a permanent life insurance policy, such as universal life insurance, that combines life insurance coverage with a “cash value” component that you can dip into for retirement money (or anything else you like). LIRPs can’t be term life insurance because term life has no cash value component.
One of the main benefits of an LIRP is its tax advantages. The cash value grows tax-deferred, so you don’t owe taxes on any gains until you withdraw them. Additionally, some policy loans and withdrawals may be tax-free as long as they don’t exceed the amount of money you’ve paid in premiums.
How Does a Life Insurance Retirement Plan Work?
With an LIRP, you pay premiums into a life insurance policy, which builds up cash value over time. The cash value can be withdrawn or borrowed against:
- Before age 59½, withdrawals and loans are tax-free when the amount you take out is less than the sum of premiums you have paid—known as the “basis.”
- All withdrawals and loans are tax-free after age 59½.
When you pass away, the death benefit of the policy is paid out tax-free to your beneficiaries, but the death benefit will be reduced by the amount of any withdrawals you took and policy loans that weren’t paid back. However, if your primary goal with an LIRP is to use the cash value, you may not be concerned about the death benefit amount.
LIRPs are essentially “overfunded” policies, meaning you can pay in more money than is required to maintain the death benefit. This excess allows the policy to accumulate cash value more quickly, which can increase the tax-free income stream available during retirement.
How LIRP Loans Work
Life insurance policy loans are a key benefit of having an LIRP. As your policy’s cash value grows, you can borrow from it to supplement your retirement income—even before age 59½. The process is relatively simple:
- Check how much you have in cash value and decide how much you want to take out.
- Request a loan from the insurance company and it will provide you with the desired amount.
- There’s no strict repayment schedule, so you can repay the loan at your convenience. One risk is that an unpaid loan will reduce your death benefit, so it’s important to manage any loans carefully. Also, the life insurance company will continue to make policy charges, and if your cash value drops below a certain level your policy can lapse. In these cases you’ll need to make more premium payments in order to keep the policy in force.
How LIRP Withdrawals Work
Withdrawals are another option for accessing your LIRP’s cash value. Before you turn 59½, you can withdraw money tax-free up to the basis. Withdrawal amounts above the basis are taxable.
After age 59½, withdrawals are not taxable.
Example of an LIRP
Say you start an LIRP at age 30. By the time you reach 65, you’ve paid a total of $175,000 in premiums, and your cash value account has grown to $700,000 due to the investment gains.
Withdrawals will be tax-free in retirement. Before age 59½, you can withdraw money without paying taxes on the first $175,000—the premiums you’ve paid. If you take out more than $175,000, that portion is taxable.
How Much Does an LIRP Cost?
What you’ll pay for an LIRP depends on these factors.
- Premiums. Your premiums will depend on the coverage amount you choose, your age, your health and other factors. Young and healthy individuals typically qualify for the lowest life insurance quotes.
- Fees. There will be charges associated with your LIRP, including administrative fees, expense fees and surrender charges. If you’re buying an LIRP, request a detailed cost disclosure document in addition to the life insurance policy illustration.
- Riders. Some LIRPs offer riders that can enhance your policy by providing coverage for long-term care or disability income. Adding riders usually increases the premiums.
- Taxes. There may be tax implications if you surrender your policy or take out too much money.
Life Insurance Retirement Plans vs. 401(k)s and IRAs
LIRPs are not a replacement for 401(k)s and IRAs. But they can be used in conjunction with the retirement plans, which work differently.
LIRP vs. 401(k)s
Here’s how a 401(k) plan compares to an LIRP.
- Employer-sponsored vs. individual. A 401(k) plan is offered and administered by an employer, while an LIRP is individually managed. Workers can be auto-enrolled into their company 401(k) plan, so there’s not much you need to do to set it up.
- Matching contributions. A 401(k) typically provides employer-matching contributions, which can significantly boost your retirement savings. LIRPs do not have this feature.
- Contribution limits. The IRS sets annual contribution limits for 401(k)s—$22,500 for 2023—while LIRPs do not have this restriction. So, you have an opportunity to save more for retirement in an LIRP. It is important to know, however, that if you overfund your LIRP too much, according to tax code 7702, it will become a modified endowment contract (MEC) and subject to different tax rules.
LIRP vs. IRAs
A life insurance retirement plan blends life insurance with potential cash value growth, while an individual retirement account is purely an investment account. Here’s a closer look at how they compare.
- Tax advantages. LIRPs are similar to Roth IRAs in that you don’t pay taxes on withdrawals after you hit age 59½. Traditional IRAs defer your taxes until you make withdrawals in retirement.
- Contribution limits. IRAs have annual contribution limits—in 2023, $6,500 if you’re under 50 and $7,500 if you’re over 50—but LIRPs do not. So you have the power to save more for retirement in an LIRP, with caution that if you overfund the LIRP more than tax code 7702 allows, it will become an MEC and subject to different taxation.
- Required minimum distributions. Unlike traditional IRAs, LIRPs do not have the mandatory withdrawals in retirement known as required minimum distributions, or RMDs. You can keep funds invested in an LIRP as long as you wish. RMDs for Roth IRAs don’t begin until after you die.
Who Needs a Life Insurance Retirement Plan?
A life insurance retirement plan may make sense if any of these situations apply to you:
- You’ve maxed out your other retirement accounts. If you hit your limits on 401(k) and IRA contributions, an LIRP could be a way to save more for retirement.
- You have a high net worth. The death benefit from your policy can be used to pay estate taxes, so your heirs may not have to sell assets to cover the tax bill.
- You want to diversify your retirement portfolio. Depending on the life insurance policy type, the cash value of an LIRP can be invested in a variety of asset classes, including stocks, bonds and mutual funds.
Which Companies Offer LIRPs?
You can find life insurance retirement plans at any company that sells cash value life insurance policies. If you’re interested in an LIRP, compare plans to find the one that best fits your needs. Talk to an insurance agent if you need help narrowing down your options.
Alternatives to an LIRP
There are multiple ways to save for retirement, so consider these alternatives to a life insurance retirement plan.
IRAs
There are two primary types of individual retirement accounts that can help you save and grow money for retirement. With a traditional IRA, your contributions lower your taxable income today, and you don’t pay taxes on the money until you withdraw it in retirement. With a Roth IRA, you pay taxes on your contributions now and enjoy tax-free withdrawals in retirement.
Workplace Retirement Plans
If your employer offers a workplace retirement plan, such as a 401(k) or 403(b), it can be a great way to save for retirement. You contribute pre-tax dollars, which reduces your taxable income for the year. Many employers provide matching contributions, which can help you save even more.
HSAs
If you have a high-deductible health plan, you may be eligible for a health savings account (HSA). Withdrawals are completely tax-free and penalty-free when used for qualified medical expenses. After age 65, you can withdraw money for any reason without penalty, but you may have to pay income tax.
Taxable Accounts
If you’ve maxed out your tax-advantaged retirement accounts, you can still save for retirement in a taxable investing account. While you won’t get any tax benefits, you’ll have more flexibility in how you grow your money and when to withdraw it.
Annuities
Annuities give retirees a guaranteed stream of income. You can purchase an annuity from an insurance company with a lump sum of money or a series of payments. Annuities come in several varieties, including fixed, variable and indexed options.