Saving enough for retirement is increasingly difficult. The amount you can contribute to employer-sponsored qualified plans is limited and access to those funds is not only subject to income taxes, but before age 59 ½, it is also penalized. In addition, discrimination testing may reduce or even prevent your participation in these plans.
Your other qualified options of IRAs and Roth IRAs have even lower contribution limits, and you likely don’t even qualify for a Roth IRA. As a result, life insurance retirement plans (“LIRPs”) are growing in popularity and may be the answer to how you can meet your retirement goals.
What is a LIRP?
A LIRP is essentially an over-funded cash value life insurance policy, such as whole life, indexed universal life or variable universal life, where the amount of money contributed is greater than the typical premium needed to maintain the policy. The intent of overfunding is to maximize the cash value for future withdrawals (up to basis) and loans which will be tax-free if the policy is structured correctly.
For a LIRP to be effective, a policy must be structured and funded as a non-Modified Endowment Contract (“non-MEC”) which requires as few as two annual premium payments. A non-MEC structure permits the policy’s cash values to be accessed via withdrawals of basis and loans that are tax-free and remain tax-free as long as the policy remains in-force.
Congress Gave LIRPs a Boost
About a year ago, the Consolidated Appropriations Act 2021 (the “Act”) changed the definition of life insurance. Now, policyholders are able to contribute upwards of three times as much premium to a new policy for the same amount of death benefit costs. This means greater savings because you will own a policy with lower costs, allowing the cash value savings component to grow even faster than was previously possible. The Act has made LIRPs a far more powerful and valuable savings tool.
Who Should Consider a LIRP?
Optimally, LIRPs are a fit for those in relatively good health who have a medium to long-term time frame before needing the tax free income a LIRP can provide – typically people in their mid-50s or younger. These candidates should first consider maximizing their qualified plans before dedicating excess cash toward building additional retirement income via a LIRP.
Best Policy Types for a LIRP
LIRPs works well with three types of cash value life insurance:
- Whole Life
- Indexed Universal Life
- Variable Universal Life
Whole Life Insurance (WL)
Whole life policies have fixed premiums that guarantee coverage for life as long as the premiums are paid. This guarantee makes whole life generally more expensive than its universal life counterparts. Cash value growth is determined by a dividend rate declared annually by the insurance company. In addition, whole life offers valuable guarantees meaning the LIRP owner does not shoulder any of the cash value investment risk.
Indexed Universal Life (IUL)
Indexed universal life is a type of universal life where, instead of the insurance company setting an interest rate upon which to base cash value growth, the policy owner is permitted to link policy performance to one or more indices, such as the S&P 500. This affords the policy owner the opportunity for greater cash value growth than with standard universal life or whole life. Most indexed universal life policies include a minimum, guaranteed crediting rate, often a 0% floor. In exchange, these policies typically have a cap. As such, indexed universal life provides ‘guardrails’ to mitigate volatility which can negatively impact long-term performance.
Variable Universal Life (VUL)
Variable universal life works off the same premise as indexed universal life except the cash value is invested into separate accounts chosen by the policy owner. Carriers of this type of product typically offer robust menus of investment choices encompassing many asset classes. Although some variable universal life policies allow the purchase of cash value performance and death benefit guarantees, many do not have restrictions to how much the cash value can grow or fall. Where a whole life policy owner has no cash value investment risk, all of that risk falls to the owner of a variable universal life contract.
Benefits of a LIRP
A LIRP has a number of attractive benefits, including tax-deferred growth of your policy’s cash value savings element, the ability to take tax-free policy distributions, and, of course, an income tax-free death benefit that can be left to heirs in the instance of an unexpected death.
You can have access to performance guarantees provided in some policies and your contributions are limited only by the amount of corresponding death benefit a life insurance company can provide. Also, you can use your policy’s cash values at any time without an age or time-related penalty. This means that your LIRP can be put to use not only for retirement but for any of your future needs such education, a second home, and/or medical expenses.
Get Started on Saving More for Retirement
As saving in traditional qualified plans becomes more complex and limited, a LIRP may be a solution to tax efficiently accumulate more for retirement. Simple to establish, often with accelerated underwriting and no income limits for participation, LIRPs are increasingly being established to meet future income need shortfalls. At Cedar Point Financial LLC, we can determine your suitability, assess your risk tolerance, assist in policy design helping you choose the best policy for implementation.