Who Should Consider LIRP?

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Physicians Thrive spoke with subject matter expert, Michael Fontanini, regarding which individuals stand to benefit the most from a life insurance strategy designed to maximize cash-value accumulation.

Life Insurance Retirement Planning (LIRP) is a complementary protection and wealth accumulation strategy that allows physicians to diversify and supplement their retirement income with the cash-value of a life insurance policy. When a universal life insurance contract is structured and managed properly by a fiduciary financial consultant, it can be a highly flexible, tax-efficient asset. 

When a prospective policy owner has a need for life insurance, a LIRP can be an effective protection and accumulation strategy.  While it is a well-established and respected strategy for high income earning individuals among financial professionals, these complex financial products tend to be less familiar to the average investor. To shed light on the right and (wrong) way to invest in a LIRP, we talked with expert Michael Fontanini ,a Master of Taxation (MT), Certified Financial Planner (CFP) and Vice President of Sales and Design with Lion Street, Inc. 

“For high income individuals, there are efficient ways to structure life insurance protection to provide a powerful double duty service:  life insurance protection to protect against an economic loss caused by an untimely death in addition to tax-efficient wealth accumulation” explains Fontanini. While the potential benefits of LIRP can be substantial, Fontanini emphasizes that LIRP is not a one-size-fits-all, magic bullet investing solution. LIRPs are one of many potential products that can offer investors financial protection and tax-efficient retirement income.

This prompts the question: What criteria makes an investor a good candidate for LIRP? Alternatively, what other products should investors consider? Here’s a rundown of some of the most important criteria for prospective policy buyers:

You have a need for life insurance. 

A universal life insurance contract with cash-value provides what Fontanini describes as a “dual function investment.” First, it provides the investor with life insurance protection. Second, the contract creates a source of supplementary retirement income. For an investor who is interested in each of these functions, a professionally designed and managed LIRP offers a uniquely flexible opportunity to blend two elements of financial planning. 

Before considering LIRP, investors should consider whether they have a need for both life insurance protection as well as additional tax-efficient retirement income. Life insurance is strongly recommended for any individuals with dependents including, children, spouses, and aging parents, as it provides a payout to beneficiaries in order to supplement your lost income or pay off debts upon your death. 

Critics of LIRP often point to the fact that policy charges are deducted from the cash value to pay for the death benefit protection element of the policy. However, Fontanini points out that these policy charges provide substantial value to investors as well: “Remember, these policy charges are not pure expense. Policy charges fund the death benefit of the policy. In the event that you do pass away, your family could get a better return than you could have gotten on any investment.” 

If the policy is optimally designed, the economic cost of the charges on the long-term cash value accumulation can be minimal. An optimal design is one in which the policy owner maximizes the amount of premium that can be paid into the policy and maintains the minimum amount of death benefit protection possible without jeopardizing the tax-free treatment of withdrawals and policy loans. In fact, the policy charges are typically the highest on a present value basis in the first 10 years than at any point thereafter. After the initial 10-15 year period, the actual charges deducted from the policy can be quite small with a competitive, properly designed policy.

In short, LIRP is a strategic way to combine two important types of financial protection: life insurance and tax-free retirement income. A financial consultant can help you determine if and how you might benefit from this dual function financial product. 

You are a high-earner. 

One of the primary benefits of a universal life insurance contract is the ability to make income tax-free withdrawals up to cost basis as well as policy loans. Policy loans can be taken out once cost-basis withdrawals have been exhausted, and loans remain income tax-free as long as the policy never surrenders and is never lapsed during life with an outstanding loan.

Different types of life insurance policies credit interest in different ways, each with varying investment risks, guaranteed minimum rates of interest, and maximum policy charges deducted from the cash value. For example, the rate of interest can be a declared fixed rate based on the carrier’s fixed income asset performance in its general account investment portfolio, a variable rate based on the daily performance of mutual fund-like investment options (in which returns can be positive or negative), or a hybrid approach that is linked to a portion of the growth of a stock market index over specific periods of time up to declared limits with a guaranteed minimum floor of 0%. In the latter structure, returns can be positive up to the declared cap and participation rate, however the policy will generally not have negative returns due to the floor. 

Because various types of life insurance have various risk-reward trade-offs, the selection of a policy should be aligned with each client’s unique risk tolerance much like traditional investments. Policies with the potential to generate better cash value results generally have higher performance risk, as the returns could be significantly better or worse than originally projected. Alternatively, higher risk policies have a higher risk of lapsing due to underperformance.

To adequately fund the policy and make the premium payments, an investor will require a significant amount of disposable income. The ideal candidate for a LIRP should earn at least $150,000 as an individual and at least $200,000 for married couples. The individual or household should also be maximizing their traditional tax-deferred retirement plan options through their employer(s).

The vast majority of physicians will meet this income threshold. However, if you are concerned about the necessary cash flow to fund a LIRP, talk with your financial advisor. 

You are already maximizing your employer-sponsored retirement fund. 

“You want to maximize any employer-provided benefits, before you invest in a LIRP,” says Fontanini. “This is especially true if your employer offers a matching component, because that is essential free money from an employer.” 

Universal life insurance contracts are intended to supplement, not replace, traditional retirement investments such as 401(k)s and 403(b)s. “If you still have additional disposable income to invest after taking full advantage of an employer-sponsored retirement plan, that’s where a cash-value universal life insurance strategy can be a beneficial addition.” 

You are at least 15+ years away from retirement.

An investor’s personal and professional investment timeline can also determine whether LIRP is an appropriate investment strategy. The previously mentioned policy charges of a universal life insurance contract tend to be front loaded in the first 10-15 years. These charges pay for the protection element as well as acquisition costs such as underwriting expenses and agent commissions. These costs are deducted from the cash value besides the cost of insurance charges during the first decade or so of a policy’s lifetime. 

Again, these policy charges fund the death benefit, which provides valuable protection to the policy owner’s family before retirement when that protection is needed most. Then, when the death benefit may be less needed during retirement, the cash value can be accessed via withdrawals up to to cost basis and policy loans. Withdrawals up to cost basis and policy loans loans remain income tax free as long as the policy never becomes classified as a Modified Endowment Contract (MEC) and remains in force until death. 

Read more about avoiding MEC status and maintaining a tax-advantaged structure. 

“After the 10-15 years, these higher charges drop off, and you only have to pay for the cost of insurance charges,” Fontanini explains. “Provided the policy is properly designed, the cost of insurance charges can be fairly minimal and considerably less costly than the taxes that would be otherwise payable with traditional investment options.” 

If you are near or of retirement age, you may prefer an investment strategy that offers faster returns with fewer upfront charges. A LIRP takes closer to two decades in order to reach its peak efficiency. A financial professional can run analytics to project a prospective policy’s costs and returns over time. 

“In the earliest years of a policy, there is no question that a universal life insurance contract costs more than alternative investments, such as buying term and investing the difference,” Fontanini cautions. “However, this is not a 5 or 10 year strategy. It’s a 20, 30 or even 40 year strategy, depending on the age of the investor. Once the policy reaches its crossover point in the first 10-15 years, it can offer extremely efficient income tax-free accumulation when designed and managed properly. Thus, it’s important to consider the long-term investment tradeoff of a LIRP.” 

Read more about alternative tax free income for physciains 

You want to diversify your investments. 

LIRP is also beneficial to help investors diversify the type of investments in their retirement portfolios. 

“Diversification does not simply refer to asset classes,” explains Fontanini. “It also describes investing in accounts with a diversity of tax treatment. For example you have a tax-deferred account like 401(k), taxable accounts such as a mutual fund or brokerage account, and then finally you have investments that offer income tax-free growth and distribution potential such as a Roth or a life insurance policy.” 

Incorporating the latter investment category into your portfolio can provide essential income tax-free cash-flow for physicians during retirement. Underestimating retirement tax burdens is one of the most common financial planning errors among physicians. It is impossible to predict your effective tax rate during retirement with certainty. If your retirement income is composed completely of taxable investment distributions, you may be in for an unpleasant surprise when tax season comes and you have little flexibility to diversify your income sources of income to help manage your effective income tax liability. Fortunately, life insurance cash-value can help provide an income tax-free cash flow that will help manage and minimize your retirement tax burden.

Learn more about how to avoid the Physician Tax Trap Triangle 

Best of all, LIRP offers both diversification and flexibility. Michael Fontanini outlines the following scenario: “Imagine someone is maximizing their 401(k) contributions, and they still have an additional $10,000 of disposable income per month that they want to invest. This person could certainly put all $10,000 into a life insurance policy, assuming they qualify for the death benefit. However, if they want even more diversity in their portfolio, they could put $5,000 into a brokerage account and $5,000 in their policy each month. With universal life insurance, there is no need to put all your disposable income towards the policy. In this way, it works beautifully as a complimentary diversification strategy for overall savings.”

Alternative investment options for consideration

In the same way that LIRPs are not a one-size-fits-all solution for tax-efficient wealth accumulation, they are not the only option for investors. For investors who do not meet the criteria above, alternative life insurance protection may be more appropriate in combination with a diversified, professional managed investment portfolio.  

Between Index Universal Life Insurance (IUL), variable universal life insurance (VUL), whole life insurance, and term policies, there are a variety of products that can provide critical financial protection in the event of a policyholder’s death. Investors should always maximize contributions to employee-sponsored retirement accounts and invest in Roth IRAs to create a tax-efficient income flow, in addition to traditional portfolio products such as stocks, bonds, and mutual funds.

Fontanini emphasized that investors should fully consider a range of life insurance products and investment options under the advisement of a fiduciary financial advisor before deciding on a LIRP. 

To learn more about LIRP and physician retirement planning, schedule an appointment with a financial advisor today.

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