Retirement: It’s that glorious time in your life when the only thing you need to worry about is why your grandkids haven’t called this week yet. Although it is a life-changing and naturally stressful occasion, it should be an easy transition from work life to retirement life, as she has been planning for this moment for what should be the last 40 years. There are a host of tools available to help you plan for his retirement, such as IRAs, 401(k)s and the like. But have you thought about using life insurance as a retirement planning tool for him?
Working in estate planning, I’ve found that many people believe that retirement accounts and life insurance are two separate tools used to plan for two separate events, retirement and death. This is not the case. Life insurance can be a valuable retirement planning tool if your situation allows.
how life insurance retirement plans work
A life insurance retirement plan (LIRP) is simple in theory. lirps are essentially overfunded policies, that is, amounts above the premiums required to keep the policy in force. the intent is to maximize cash value for future loans. You finance the whole or universal life insurance policy and borrow against the accumulated cash value through a tax-free loan. There are many benefits to including a LIRP in your retirement planning. tax-deferred accumulation, asset protection and penalties, and tax-free distributions, to name a few. Because life insurance is taxed on a “first in, first out” basis, this tax-free “loan” can be offset up to the basis, or whatever you’ve already put in. each year, you’ll accrue interest and your account value will grow.
who can benefit from using lirps?
This technique is not right for everyone and is not a replacement for your 401(k)s or IRAs. If you’re at a point in your life where you don’t need life insurance, you may want to consider a Roth. Also, consider maxing out your 401(k) and IRAs before funding a LIRP, as employers will often match your contribution up to a certain limit, which is essentially “free money” for you. If you’ve already maxed out on your other tax-advantaged retirement savings plans, LIRPS may be a good alternative for a tax-free stream of income in retirement.
High net worth individuals would qualify for this strategy, as oftentimes the contribution limits for 401(k)s and IRAs are not enough to meet their retirement goals. a significant benefit of lirps is that there is no contribution limit.
Let’s look at an example that explains in more detail how lirps work as a retirement planning tool. john and jane are high net worth people. John was a successful businessman and Jane was a doctor. they are currently retired and both are 65 years old. they are currently withdrawing $70,000 per year from their retirement accounts (IRAs and 410(k)s). they are also receiving $30,000 per year from social security. your taxable income is $100,000. this is a problem for them, since they, like many people, want and need to be in a lower tax bracket in their later years.
now let’s say john and jane planned differently. they implemented a lirp years ago for retirement. Let’s say instead of taking the $70,000 from their retirement accounts, they take out a tax-free loan from their LIRP. your taxable income is now $30,000. this is also essential as it is not added to your provisional income, which is used to calculate your excise tax on social security withdrawals. The higher your provisional income, the more of your Social Security will be taxable (up to 85%).
Can you see how this can be used as a helpful retirement planning tool for some? If this strategy is right for you, there are benefits other than using it out of necessity because it maximizes your traditional options.
• Safety: Let me bring you back to 2008, which I know many people remember very well. the market crashed. retirement plans were devastated. however, the chants were not. lirps provides a “floor” where it is not possible to make less than 0% (sometimes more depending on the type of policy). Security is key when planning for retirement.
• Coverage: In addition, coverage against ever-increasing tax rates is important. In most cases, retirement strategies are fully taxed or tax-deferred. Because taxes inevitably increase, you’ll never pay taxes on a life insurance loan up to the base. this is critical when trying to get to the “0% tax class”.
• Death and long-term care benefit options: One of the biggest advantages besides retirement income stream is long-term care benefits. Most policies provide accelerated death benefits that are available if you become terminally ill, which can help protect you and your family. the death benefit is an obvious and critical part of this plan. it is also a security feature for your heirs. If you die prematurely, the death benefit will be paid to your beneficiaries tax free, net of your loan that you have already taken as a retirement income stream.
Always remember that there is no one-size-fits-all retirement plan. a professional financial advisor can help you learn more about whether this strategy would benefit you.
The information provided here is not investment, tax or financial advice. You should consult a licensed professional for advice on your specific situation.