The Pros and Cons of LIRP or Life Insurance Retirement Plan

Thang Truong
Thang Truong
Updated on:

When you approach your golden years, you’ll want to consider all sources of income to fund your retirement. In addition to 401k, IRA’s, social security, and investment income, you can also use the cash value in a cash value life insurance policy. 

What is a LIRP or Life Insurance Retirement Plan?

A life insurance retirement plan (or LIRP) is when you use the cash value account from your cash value life insurance to fund your retirement. If you own any kind of permanent life insurance policy with a cash-value component, you can use this strategy. If you have term life insurance, you don’t have any cash value to tap into. Even guaranteed universal life insurance is a permanent policy, it offers very little cash value, so in general, you can’t rely on it for your retirement income.

Once the cash value has built up over time, you can either withdraw from it or take out a loan against it. Learn how to use life insurance in retirement planning through a case study.

Life Insurance Policies that Can Be Used as Life Insurance Retirement Plans:

For more on these types of policies, see the pages linked above. Also see the following:

Advantages of LIRP or Life Insurance Retirement Plans

  • No limits on income that can be contributed. If you are not qualified to contribute to Roth IRA due to high income, this is an excellent option
  • No limits on contributions. If you already max out the eligible contributions to your 401K and IRA accounts, this is an excellent option for you to save more for your retirement. You can contribute as much as you want.
  • Growth is tax-deferred and tax-free when withdrawing. This is a significant advantage compared to an usual investment account where you have to pay long-term capital gain tax on investment gain when withdrawing.
  • Plans never lose value, except in variable universal life insurance or VUL policy, thanks to floor rates of 0% or 1% when the market declines
  • Guaranteed death benefit for heirs, tax free
  • You can withdraw or take loans from the policy as tax-free income
  • No penalty when you withdraw before 55 years old. You can start withdrawing from the policy, tax-free, as soon as the cash value account in your policy can support withdrawal, however young you are
  • Access to accelerated death benefit, should you become ill or need long-term care
  • Doesn’t count as income when calculating your social security taxes

Below are the detailed explanation of these advantages:

No limits on income: If you work for a company that doesn’t offer a 401K plan or if your income is too high to contribute to a Roth IRA account, LIRP or life insurance retirement plan is a perfect option for you to save for retirement. It doesn’t matter if your company offers 401K plan or not and it doesn’t matter how much your income is, you can always have a LIRP or life insurance retirement plan as long as you have good health.

No limits on contributions: Some IRA’s and 401 (k)’s limit the amount of money you can contribute to the fund in a given year. People with high incomes and an ambitious financial strategy for retirement run into this problem. There is no contribution limit to a LIRP or life insurance retirement plan, so you can contribute as much as you’d like as long as it doesn’t trigger the policy to become a Modified Endowment Contract or MEC.

>>MORE: Indexed Universal Life Insurance vs. 401K

Investment growth or gains and withdrawals are 100% tax-free: You can access any money earned by the the cash value account tax-free. Whatever money is in the cash value account can be yours in the form of tax-free as long as you don’t withdraw too much to have the policy lapse. If you have the policy lapse, you will have to back-pay income tax on all withdrawals.

Plans never lose value: In an uncertain global economy, the stock market can fluctuate wildly. After all, in 2008 the stock market crashed and millions of people lost billions of dollars. Life insurance will never lose money, since there’s a floor on how much the policy can earn, typically 0-1% when the market declines.  This is with an exception of variable universal life policy which doesn’t have any floor or ceiling limit earnings.

Guaranteed death benefit: If you have no need of the insurance money, you will still have a tidy sum to leave to your heirs, which is tax-free for them. 

Access to tax-free income: The main benefit of a LIRP or life insurance retirement plan is the access to tax-free income. Social security is taxed at rates of up to 85%, plus many people are in doubt about the future of social security. Any distribution you get from an IRA or a 401 (k) is also taxable. Taxes will definitely take a bite out of the money you save for retirement, so it’s a good idea to have access to tax-free income. 

No penalty when you withdraw from the policy before 55 years old: Unlike 401K or IRA or even Roth IRA account which allows you to withdraw without having penalty at 55 or older, you can withdraw from LIRP or life insurance retirement plan at any age as long as the cash value in the policy can support such withdrawals.

Accelerated death benefit: Should you become ill or require long-term care, you have access to the death benefit while still being alive. This can help pay medical bills and other costs. 

Doesn’t count as income when calculating social security taxes: The Social Security Administration (SSA) sets the parameters for how your social security income is taxed

  • If you are single with an income of less than $25,000, or less than $32,000 for a couple filing jointly, your tax rate on social security is 0%
  • If you are single with an income between $25,000 and $34,000, or married with an income of $32,001 and $44,000, your benefits are taxed at 50%
  • If your income exceeds $34,001 as a single person or $44,001 for a married couple, your tax rate is 85%.

The money you earned through a LIRP or life insurance retirement plan is not calculated into these amounts, so it doesn’t count. 

That’s quite a few pros. Let’s take a look at the drawbacks.

Disadvantages of LIRP or Life Insurance Retirement Plans

  • Permanent or whole insurance policies carry high premiums, up to ten times higher than term insurance
  • There are interest rates paid on those tax-free loans if you withdraw more than your total paid-in premiums
  • Failing to pay back the loans will reduce your death benefit
  • If you fall on hard times and can’t pay premiums, the policy may lapse (although you can use your cash account value to pay the premiums first)
  • Comparison shopping is difficult

And we are explaining the details of these disadvantages below:

Permanent or whole life insurance policies are expensive: Premiums for these types of policy can be as much as ten times higher than a simple term life insurance policy. 

Interest rates on tax-free loans if you withdraw or borrow more than your paid-in premiums: The growth you accumulated through the cash value is yours to borrow against. If borrow more than your total paid-in premiums, however, there is an interest on the loan that you have to pay. For example, if you have an indexed universal life insurance policy. When you reach 65 year old or the 25th year of the policy, you have paid a total of $75,000 premiums, the total cash value of the account, is, for example, at $280,000. When you withdraw up to $75,000, you don’t have to pay tax nor interests. However, if you want to withdraw another $25,000, this will be considered as a loan against from your policy. It is still tax-free but you may have to pay an interest of 4-6%. If you don’t pay back the loan and interest, they will be deducted from the death benefit.

Failing to back loans will reduce the death benefit: If you borrow too much money, your heirs will have a reduced death benefit.

If you fall on hard times and can’t pay the premiums, the policy may lapse: Unlike an IRA or a 401 (K) you have to pay your premiums, even if you are in a cash-poor phase of your financial life. If you stop paying the premiums, the policy will lapse and then the policy does you no good at all. In general, you can borrow from your cash value account to pay for premiums first, but this can’t last forever.

Comparison shopping is difficult: Insurance companies are usually reluctant to offer online quotes for permanent life insurance policies because there are so many variables involved. How do you know you’re getting a good deal? You would have to fill out forms with multiple companies and talk to several different agents to compare. You could go through an insurance broker, which compares the rates at several companies, but not all. 

Who is a LIRP or Life Insurance Retirement Plan For?

Traditionally, LIRP’s were marketed towards wealthy people who needed tax-free places to put their cash. And it is true that if your employer matches funds, you might be better off making the maximum contribution to an IRA or a 401(K). 

However, people who are risk averse but want some tax-free retirement income might do well to consider a LIRP. It’s important to realize that a LIRP is a long-term strategy. If you don’t or can’t stick with it and make the premiums, you’d be better off with another type of investment. But the key to a good retirement plan is a diverse portfolio, and a LIRP could have a place in yours. 

Thang Truong
Thang Truong

Thang Truong covers small business insurance and small business success at BravoPolicy. He is a licensed P&C insurance agent. Previously, he held product leadership positions at, Capital One, NerdWallet, and Mulberry Technology. He holds a MBA degree from UC Berkeley - Haas School of Business.

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