There are different ways you can prepare for your retirement. A life insurance plan is one of them and is majorly designed to benefit you financially when you lose a loved one. You can also use it to save a significant amount of retirement income. Remember, a life insurance retirement plan (LIRP) cannot fully replace your 401(K) or IRA but can supplement your retirement planning strategy.
A LIRP is simply a permanent life insurance cover, like universal life insurance. It combines life insurance cover with a cash value element that you can easily dip into for your retirement cash or other expenses. A LIRP cannot be term life insurance because such coverage options have no cash value aspect.
One of the top benefits of a life insurance retirement plan is its tax advantages. The cash value usually grows tax-deferred, which means you don’t owe tax on the gains until you withdraw them. Similarly, some policy withdrawals and loans might be tax-free if they don’t exceed the amount of money paid in premiums.
How a Life Insurance Retirement Plan Works
With a life insurance retirement plan, you pay premiums into your life insurance cover, which builds up your cash value over time. You can withdraw or borrow against the cash value. Before you turn 59 ½ years, all loans and withdrawals are tax-free if that amount is less than the total premiums you have paid (basis). After this age, all loans and withdrawals will be tax-free.
When you (the policyholder) pass away, your death benefit is paid out to your beneficiaries, and this amount is tax-free. However, the death benefit will be reduced by the total withdrawals you may have taken and the total policy loans not paid back. If your goal with your LIRP is to benefit from the cash value, don’t worry about the death benefit.
Generally, a LIRP is an ‘overfunded’ cover. That means you can pay in more cash than needed to maintain your death benefit. The excess amount allows your policy to build a cash value quickly. This can increase your tax-free income stream, which will be available during your retirement.
LIRP Loans
These loans are one of the top benefits of having a life insurance retirement plan. As your policy’s cash value accumulates, you can take out a loan from it to supplement your income even before age 59 ½. It’s simple.
- Check the amount of cash value your policy has accumulated
- Determine the amount you want to borrow
- Request that loan amount from your insurer, and you will get it
There is no strict loan payment schedule. That means you can pay your LIRP loan at your convenience. One of the risks is that unpaid loans will reduce the amount of your death benefit. So you should manage your loans carefully.
Remember, your insurer will continue to charge your policy, and if its cash value drops below a specified level, the entire policy can lapse. If this happens, you will need to make more (or higher) premiums to keep the policy active.
LIRP Withdrawals
Another way of accessing your LIRP’s cash value is withdrawals. Before you turn 59 ½ years old, you will be able to withdraw cash tax-free up to an amount less than the total premiums you have paid (basis). Withdrawals beyond the basis amount are taxable. Similarly, all withdrawals you make when you are over 59 ½ years old aren’t taxable.
Suppose you start a life insurance retirement plan at the age of 30. By the time you’re 65 years old, you will have paid about $175,000 in premiums. Your cash value account will have grown to about $700,000 because of investment gains.
As mentioned earlier, all withdrawals in retirement will be tax-free. But before you are 59 ½ years old, you can withdraw tax-free money on $175,000, which will be considered the basis – the total premiums you have been paying. If you decide to take out over $175,000, the extra portion is taxable.
What are the Benefits of a Life Insurance Retirement Plan?
LIRPs are an important tool for effective retirement planning, and it’s recommended that you understand their benefits and limitations. Here are the benefits of LIRPs.
- Tax-free income in retirement
- There are no contribution limits
- Tax-free death benefit for your beneficiaries
- Guaranteed return rates on your cash value
- No required minimum distributions
Here are the limitations of LIRPs;
- You are likely to pay high premiums and fees
- They are not a standalone retirement solution
- Unpaid loans and excessive withdrawals often reduce the death benefits
- If the cash value drops below a specified level, your policy will lapse
- You need a substantial amount of cash value to enjoy tax-free income
What’s the Cost of LIRPs?
The amount you will pay for your life insurance retirement plan policy depends on the following factors;
Premiums
Your policy premiums will depend on the insurance coverage amount you prefer, your health, age, and other related factors. To this end, young and healthy policyholders are more likely to qualify for the lowest insurance quotations than elderly people with deteriorating health.
Fees
There will be charges linked to your life insurance retirement policy. These include expense fees, administrative fees, and surrender charges. So, if you plan to buy a LIRP, request a detailed cost quotation (disclosure) document in addition to a thorough policy illustration.
Riders
These are extra benefits that you (the policyholder) can purchase to add to your life insurance policy. They often provide extra protection if you meet their requirements. Some life insurance retirement plan policies offer riders to improve their policy by offering disability income or long-term care. Adding riders will increase your premiums.
Taxes
There are tax implications when you withdraw money from your cash value account beyond a certain limit. Similarly, taking out too many loans from your account or surrendering your LIRP will also have tax implications.
Who can get a Life Insurance Retirement Plan?
There are many situations where a LIRP can be beneficial. Suppose you are already contributing the highest possible amount to your IRA or 401(K). In that case, you may be ready to buy a permanent life insurance plan as part of your retirement strategy.
If you have a loved one who depends on you for financial support, buying a LIRP allows you to prepare for your retirement. It also protects your loved ones (the beneficiaries) if a tragedy were to strike – the beneficiaries will get the death benefit amount.
Lastly, a LIRP allows you to save additional money outside the IRS and 401(K) limitations. This way, you can achieve significant financial targets for your retirement. Note that you can only contribute $19,500 to your employer-sponsored 401(K) and up to $7,000 to your IRA annually if you are more than 50 years old.
Life insurance retirement plans are not designed to serve as a sole retirement plan. They are used in conjunction with other retirement plans, such as 401(K) and IRAs, to supplement retirement income with flexible cash value elements. So, speak to a licensed financial advisor to determine if an LIRP is an effective way to achieve your retirement goals.
