What is a Life Insurance Retirement Plan?
A life insurance retirement plan (LIRP) is what it sounds like: a plan to use your life insurance policy as an income source during retirement. For this to work, you need to have permanent life insurance coverage.
LIRPs, also called retirement income policies, aren’t actually insurance products sold under either of those names. To be clear, you can’t go out and buy a LIRP. Instead, you’ll need to buy a permanent life insurance policy with the intention of establishing a LIRP.
You need permanent life insurance for this type of retirement planning because permanent coverage includes a cash value component. That’s a savings vehicle that lives within the policy and grows over time. The following types of policies can function as a LIRP because they include cash value:
- Whole life insurance
- Universal life insurance
- Variable life insurance
- Variable universal life insurance
- Indexed universal life insurance
Growing your cash value
The above types of permanent life insurance can become retirement income policies because they each grow your cash value over time, partially via a contribution taken from each premium payment you make and partially via growth at either a steady, preset rate or at a rate tied to market performance, depending on your policy terms. If your policy pays dividends, you also have the option to add them to your cash value.
Making larger-than-required premium payments can grow your cash value faster, but keep an eye on IRS guidelines. If you pay too much in premiums over the first seven years of holding the policy, the IRS can classify it as a modified endowment contract (MEC). That would eat into the tax benefits you get from your cash value down the road.
How to use your cash value during retirement
Once you reach retirement age, you have a few options for using your policy’s cash value, executing on your life insurance retirement plan:
Withdrawals. You can take money from your cash value account once it has accrued a sufficient value. If you take out less than you’ve paid into the policy in premiums up to that date, the IRS sees it as a return of premiums, which means the withdrawal is tax-free.
That doesn’t mean, however, that withdrawals are downside-free. For starters, your withdrawal might reduce your policy’s death benefit by an amount greater than the withdrawal itself. Additionally, if you take too much and your cash value reaches zero, your policy will lapse, voiding your coverage.
Loans. You can also explore taking a low-interest loan from your insurer. Your cash value serves as collateral, so there’s no approval process and the loan doesn’t affect your credit score. That said, any amount outstanding at the time of your death will be subtracted from your death benefit before it’s paid to your beneficiaries. As a result, this option is generally only advisable for people who no longer need to leave their full death benefit to their beneficiaries.
Surrender. If you no longer need your coverage, you can give up the policy in exchange for the cash value, minus any surrender fees that may still apply.
Because using your cash value in retirement can compromise — or even eliminate — your death benefit, using a policy as a LIRP best serves people who don’t need to leave as much behind for their beneficiaries.
Don’t rely on LIRPs
Financial advisors across the board — both insurance experts and those in other fields — recommend using a life insurance retirement plan only as a source of supplemental income. They say it should not be your primary source of retirement income, mainly because there are other ways to invest in your retirement that offer higher ROIs.
Specifically, when you establish a LIRP, part of your premium payments goes toward your retirement planning by way of your cash value, certainly, but a large portion of those payments go toward maintaining your insurance coverage. That means your cash value will grow relatively slowly.
Plus, cash value growth rates are limited. Rather than paying more than is required in premiums, you’ll generally see a better return by investing the money in other retirement planning tools, like a 401(k) or IRA.
All that said, if you have your other retirement savings accounts at comfortable amounts, your permanent life insurance policy can give you a way to create supplemental income. If you’ve already maxed out your 401(k) or IRA contributions for the year, for example, you can explore paying more into your life insurance policy to bolster your cash value.
Ultimately, though, a life insurance policy should also be a source of bonus retirement income, not the primary revenue stream on which you rely after retiring.