You know that life insurance was designed to provide financial support to your family when you’re gone. But did you know that it might also be able to provide a tax-preferred retirement income stream while you’re alive?
Life insurance retirement plans, or LIRPs, are based on the concept that many permanent life insurance policies have cash value that you can withdraw or borrow from. Here’s a look at how they compare to other retirement income solutions, as well as an overview of benefits and other considerations.
How are LIRPs different?
With a traditional IRA or 401(k), funding comes from pre-tax dollars, earnings grow tax-deferred, and distributions are taxable as ordinary income. A LIRP operates more like a Roth IRA or Roth 401(k), as it’s funded with after-tax dollars. Money withdrawn or borrowed from the policy usually isn’t taxable as income, as long as the policy doesn’t lapse and you leave a portion of the death benefit intact.
The death benefit itself usually passes to heirs free of income tax, and the LIRP strategy requires that the life insurance policy stay in force until the death of the insured to preserve the tax preference. Your tax advisor can provide more insights on how a LIRP may impact your tax picture.
Unlike most retirement accounts, a LIRP typically allows you to withdraw funds with no penalties at any time, for any reason, regardless of your age or how long you’ve had the policy. In addition, there are no contribution limits or income restrictions to qualify for a LIRP, unlike a Roth account.
4 advantages of a LIRP
- Access to funds. Depending on how the LIRP is structured, you may be able to access the policy’s cash value through withdrawals (more common with a whole life contract) or loans (more common with a universal life contract). Withdrawals can’t usually be paid back to the account, so it could permanently reduce the policy’s cash value. Loans can be repaid to the policy with interest, but most LIRP strategies are designed to have any outstanding loans paid back from the death benefit when the insured passes away.
- Down-market buffer. Accessing funds from a life insurance policy not directly correlated to the stock market may help you avoid losses that could occur if you tap market-related income streams when the market is flat or down. You would still need to take required minimum distributions from traditional IRAs or 401(k)s during a down market. But taking only that minimum amount and filling income gaps with funds from the cash value of your life insurance policy may allow other investments to recover.
- Diversification. Typically, a retirement savings strategy works best if it has taxable, tax-deferred and tax-preferred buckets, where a LIRP fits. This gives you financial flexibility. For instance, if you want to buy a second home, taking a larger distribution from a tax-deferred account could increase your taxable income and push you into a different tax bracket. Taking the money from a tax-preferred LIRP typically won’t impact taxable income.
- Options. You may access the cash value of a LIRP (within the policy parameters) at any point. But if you never need to do that, the death benefit remains intact for beneficiaries. There’s no pressure to make a decision upfront.
On the other hand, the death benefit of a LIRP strategy can be accessed to help protect against the risks of an unforeseen event and provide the surviving spouse with assets to maintain their lifestyle. This benefit of transferring the risk of an unforeseen event is not available when saving in an IRA or 401(k) — annual additions would stop in this instance and the surviving spouse would have to adjust their lifestyle accordingly. In fact, many retirement plans factor in annual savings over your working years and may be impacted if something unexpected happens to the primary wage earner.
The combination of cash value and death benefit helps ease the burden of trying to determine exactly which financial goal to fund first — for example, retirement, future purchase or protection against premature death.
3 more facts about LIRPs
- Qualifications. You’ll usually need to meet insurer medical requirements to qualify for a life insurance policy. You’ll also typically need to show financial justification — for instance, showing that the policy would be needed by your heirs to replace income or cover liabilities after your death.
- Costs. You’ll pay premiums to open and maintain a life insurance policy. You may be able to make adjustments to the contract, but the LIRP strategy usually works best when the premiums continue to be paid as originally scheduled. Otherwise, the value of the policy can be significantly reduced. The insurer may also have fees related to managing the policy or accessing your cash value within a certain timeframe of opening the account.
- Monitoring. As with other investments, it’s a good idea to keep tabs on the performance of a LIRP and its expected future performance. This may include reviewing the performance of any underlying index, as well as any changes to insurer charges. Monitoring can help manage expectations so you can then adjust your overall financial plan as needed.
Is a LIRP right for you?
A LIRP isn’t necessarily right for everyone. Life insurance should not usually be used as your primary source of retirement savings, but rather as a supplement to offer additional layers of diversification. A LIRP should not be implemented if there is no need for death benefit protection and/or there is not sufficient projected cash flow to fund the required excess premium payments.
Still, a LIRP can be a very viable solution for certain clients and might be worth discussing as part of your retirement and financial planning. Your Hancock Whitney Financial Advisor can work with you to see if this strategy makes sense for you.
The information, views, opinions, and positions expressed by the author(s), presenter(s), and/or presented in the article are those of the author or individual who made the statement and do not necessarily reflect the policies, views, opinions, and positions of Hancock Whitney Bank. Hancock Whitney makes no representations as to the accuracy, completeness, timeliness, suitability, or validity of any information presented.
This information is general in nature and is provided for educational purposes only. Information provided and statements made should not be relied on or interpreted as accounting, financial planning, investment, legal, or tax advice. Hancock Whitney Bank encourages you to consult a professional for advice applicable to your specific situation.
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