Life Insurance Retirement Plans [LIRP] & When To Get One

Key Takeaways

• A Life Insurance Retirement Plan (LIRP) is for high-income individuals, combining wealth accumulation with life insurance coverage.
• LIRP is best for those with significant disposable income who have maximized other retirement savings options and investors who are at least 15 years from retirement due to front-loaded costs.
• After the initial 10-15 years, policy charges drop significantly, making the policy more cost-effective.
• Life Insurance Retirement Plans should be used to supplement employer-sponsored retirement plans, not as a replacement.
• A LIRP should be optimally designed to minimize taxes on distributions and policy loans.
• A diverse portfolio, including tax-free accounts like LIRP, is recommended for retirement planning.

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What is a Life Insurance Retirement Plan?

A Life Insurance Retirement Plan (LIRP) is a complementary protection and wealth accumulation strategy.

It allows physicians to diversify and supplement their retirement savings with the cash value of a permanent life insurance policy.

While it is a well-established and respected strategy for high-income earning individuals among financial professionals, these 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 coverage 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 life insurance retirement plans can be substantial, Fontanini emphasizes that LIRP is not a one-size-fits-all 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 qualifies an investor for LIRP? Alternatively, what other products can they consider?

What Criteria Qualifies an Investor for LIRP?

Here’s a rundown of some of the most important criteria for prospective policy buyers.

You Need a Life Insurance Retirement Plan

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 flexible opportunity.

Blending two elements of financial planning.

You are a High-Income Earner

One of the primary benefits of a universal life insurance contract is the ability to make income tax-free distributions at a cost basis.

As well as policy loans. High-income earners wind up in higher tax brackets. This means you, of course, pay more to the IRS each year.

You can take out policy loans once you’ve exhausted contribution limits.

Outstanding loans under these qualified plans remain income tax-free as long as the policy never surrenders or lapses during life.

Different types of permanent life insurance policies credit interest in different ways, each with varying investment risks, guaranteed minimum interest rates, 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 links 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.

You’re 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 essentially free money from an employer.”

Indexed universal life insurance contracts are intended to supplement, not replace, traditional retirement investments such as 401(k) and 403(b) plans.

“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.”

Related: The Pros and Cons of Retirement Protection Riders for Disability Policies

You’re At Least 15+ Years 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 deductible 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, particularly before retirement when you need that protection.

An accelerated death benefit may be unnecessary during retirement.

The cash value can be accessed via withdrawals up to cost basis and policy loans.

Withdrawals up to cost basis and policy loans remain an income-tax-free death benefit 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.”

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, professionally managed investment portfolio.

Between Index Universal Life Insurance (IUL), Variable Universal Life Insurance (VUL), Whole Life Policies, and Term Life Insurance Policies, there are a variety of products that can provide critical financial protection in the event of a policyholder’s death.

Always maximize contributions to social security and employee-sponsored retirement accounts.

Also, you can invest in Roth IRAs to create a tax-efficient income flow.

This is all in addition to traditional portfolio products such as stocks, bonds, and mutual funds.

Fontanini emphasizes that investors should fully consider a range of life insurance products and investment options.

Accordingly, 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.

Best Practices for LIRP Investors

1. Consider the Benefits of Life Insurance and Retirement Income

Before considering LIRP, investors should consider whether they require life insurance protection and additional tax-efficient retirement savings.

Professionals strongly recommend life insurance for individuals with loved ones, including children, spouses, and aging parents who need long-term care.

It provides a payout to beneficiaries to supplement retirement funds or pay off debts upon one’s 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, not just the insurer: “Remember, these policy charges are not pure expenses.”

Policy charges fund the death benefit of the policy. If you do pass away, your family could get a better return than you could have on any investment.”

2. Plan Your Policy Stipulations Well

If the policy is optimally designed, the economic cost of the charges on long-term cash value life insurance 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 while maintaining the minimum amount of death benefit protection possible.

However, this should be done 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.

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 determine if and how much cash value you might benefit from this dual-function financial product.

3. Pick Your Policy Like Your Investments

Because various types of life insurance have various risk-reward trade-offs, selecting 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.

4. Retirement Strategy

If you are near retirement age, you may prefer an investment strategy that offers faster returns with fewer upfront charges.

A LIRP takes closer to two decades 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 terms 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 investor’s age.

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 physicians

5. Diversify Your Investments

LIRP is also beneficial in helping 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 a 401(k), taxable income accounts such as a mutual fund or brokerage account, and 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.

6. Always Consult With a Tax Professional

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. Be careful if your retirement income is composed completely of taxable investment distributions.

You may be in for an unpleasant surprise when tax season comes.

Consulting tax professionals who understand your needs as a physician is crucial.

That type of taxable investment build-up means you have little flexibility to diversify your income sources to 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 tax burden with effective retirement planning.

Get Physician Specific Financial Planning

Life Insurance Retirement Plans offer desirable advantages, from diversification to tax benefits.

However, they can be tricky to navigate and require professional help.

If you’re on the fence about what to do next, we have experienced financial advisors willing to assist you. Contact us today and work with advisors who understands physicians.