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LIRP Case Study: LIRP vs A Vanguard Retirement Account: Which is Better?

We have discussed the benefits of cash value life insurance and how to use it to supplement retirement income. The reason that a cash value life insurance policy is better than an investment account, like mutual fund account, is that, unlike in an investment account, the investment gain in a cash value account of a permanent life insurance policy is income tax free. You usually have to pay at least 35% income tax on the capital gain of your investment account. That’s the reason why more and more people are using cash value life insurance, especially indexed universal life or variable universal life, for their retirement planning.

To illustrate the advantage of indexed or variable universal life insurance policy in retirement planning, we are examining a case study below. Learn more about the pros and cons of LIRP or life insurance retirement plan.

The Case of Having a LIRP or Life Insurance Retirement Plan

Anna is 40 years old, a senior marketing manager living in Bay Area. She works at a tech firm and makes $170,000 a year, before bonus. She and her husband have two kids, aged 7 or 12. They own a beautiful home in Oakland, California. They already match their 401K contribution and IRA account. They have also set aside a healthy emergency savings account, which can last 6-12 months, if anything happens.

She believes that she can set aside $300 a month until she reaches 60 years old without affecting her family lifestyle. She wants to invest this amount in a mutual fund investment account or a cash value life insurance policy which maximizes her cash distribution when she reaches 65 years old. Ideally, she wants to receive cash distribution from the policy until she is 75 years old when she starts withdrawing from her social security and 401K account. Let’s see which option will provide her with more annual cash withdrawal during the 15 years old, from 60 to 75 years old.

How Much Retirement Income does A LIRP or Life Insurance Retirement Plan can Provide?

Getting several illustrations from several life insurance companies, we found that Anna can invest in a LIRP or life insurance retirement plan and can expect to have up to $25,800 annually for 11 years from 65 to 75 years old with Accordia Life and Annuity Company and its Lifetime Builder Elite 2020 product. The illustration of Lincoln WealthAccumulate IUL product of Lincoln Financial Group provides $24,800 annual cash withdrawal for 11 years. Both are indexed universal life insurance products.

Out of 44 universal life insurance products that we examined, these are the top 6 products that. These products, based on their non-variable policy illustrations, can provide Anna with annual cash distributions of $20,400 to $25,800. These illustrations use the carrier-default return rates for their non-variable universal life insurance products, which range from 5-7%. In the case of Accordia’s Lifetime Builder Elite product, they use 7.63% return rate and Lincoln WealthAccumulate IUL uses 5.92% to calculate their policy illustrations.

It appears that Lincoln WealthAccumulate IUL product might have a lower internal charges than Accordia’s Lifetime Builder Elite product.

These estimated cash distributions are non-guaranteed, of course. They can be higher or lower depending on the actual investment return rates of the policy in the next 40 years if Anna buys the policy today. The average returns of S&P 500 Index of the past 25 years, from 1994 to 2018, is 6.96%.

Since in this case, Anna’s main objective is to maximize cash distribution when she is 65 to 75 years old, we design these policies in the way that death benefits are reduced as much as possible to maximize cash distributions. Therefore when she reaches 95 years old, non-guaranteed death benefits are as low as $2,500 or as high as $54,300. And again, these are non-guaranteed death benefit since they all depend on how the market perform in the next 55 years when she reaches 95 years old.

>>MORE: Understanding Indexed Universal Life Insurance – Is It Good for Retirement Planning?

Retirement Income from a LIRP with Variable Universal Life Insurance or VUL Policy

We also found 4 policy illustrations of variable life insurance policies and compare them against one another. The policy that estimates the highest annual cash distribution for Anna is Lincoln Financial Group with its AssetEdge VUL product at $23,400.

All variable universal life insurance policies use 8% investment return rate in their illustrations.

It may appear that unexpectedly VUL policies do not provide a higher retirement income than indexed universal life policies since VUL policies are known to be the product that focuses on maximizing cash value. They might if the actual investment return is higher than 8%, which is more likely to be the case. And that is because insurance companies can invest the cash value account of VUL policies in a wider range of assets, which might yield a higher return.

However, at 8%, which is higher than 5-7% return rate used in non-variable universal policy illustrations above, why variable policies’ cash distributions are lower than non-variable policies. This is because investment management fees in variable policies are higher than those in non-variable policies and the difference in return rates used in these illustrations are not enough to account for higher fees.

In reality, variable universal life insurance policies can grow cash their cash value account much faster if the market performs well. For example, if the market’s return rate in a year is 25%, variable universal policies will fully benefit from this high return rate whereas in non-variable policies, there is a cap, usually at 9-10%. On the other hand, in bad years when market decreases, variable policies will suffer whereas non-variable policies will trigger loss limit at 0% or in some cases 1%. It is classical with high-risk and high-return in investment.

So, depending on your risk appetite and your prospects in the market performance for the next 40 years, you can decide if you prefer a variable universal policy or a non-variable policy like indexed universal life insurance.

>>MORE: Is Whole Life Insurance Good for Retirement Savings?

How Much Retirement Income can a Vanguard Retirement Account Provide?

What if Anna decides to invest $300 a month in an retirement investment account like Vanguard. Let’s see if she can withdraw the same amount $25,797 on annual basis for 11 years from 65 to 75 years old?

If she invests $300 a month in Vanguard account for 20 years from 41 to 60 years old, her Vanguard account value will reach $261,427 when she is 65 years old, if we assume the average annual return rate is 8%, which is higher than the return rates that Accordia and Lincoln Financial use in the illustrations of their IUL products above.

If she wants to withdraw $25,797 a year, after tax, for 11 years, from 65 to 75 years old, she has to withdraw $39,688 before tax from her Vanguard account since she has to pay about 35% capital gain tax when she withdraw. It is obvious from the calculation below that she won’t have enough money by the time she is 73 years old.

Why does LIRP Provide Better Retirement Income than a Vanguard Retirement Account?

The short answer is the advantage of not paying long-term capital gain tax when withdrawing.

To further illustration the impact and advantage of income tax, let’s assume that she doesn’t have to pay capital gain tax when she withdraw from her Vanguard account, let’s see how long her Vanguard account will last:

Without paying long-term capital again tax, Anna can withdraw $25,797 annually for 18 years from 65 to 82 years old from her Vanguard retirement account

It is clear that long-term capital gain tax has a massive impact on a retirement account. And that’s the reason why a cash value life insurance policy can be an extremely effective tool for your retirement planning.

Final Thoughts

  • A cash value life insurance such as indexed universal life or variable universal life insurance can be very effective in providing you with supplemental retirement income.
  • The advantage of tax-free withdrawal from the cash value account of IUL policies makes a LIRP better than a Vanguard retirement account in providing you with supplemental retirement income.
  • VUL policies can provide more cash distributions if the market performs well. However, IUL. policies are also great options and may be better in a volatile market condition.
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