Life insurance isn't just a way to cover your final expenses. Some policies build up cash value, which is money you can use on expenses while you're still alive. This setup is called a life insurance retirement plan (LIRP). Here's what you need to know about this approach, including the pros and cons, and how to decide whether it's right for your financial situation.
How Does a LIRP Work?
With a life insurance retirement plan, you simply purchase a policy that builds cash value, but not all life insurance policies include this feature. Permanent policies that last your entire life, such as whole life or universal, typically include cash value accounts, whereas temporary term policies do not.
If you have a policy with this benefit, your insurance premium payments will build up a reserve of cash value. The longer you own the life insurance, the more you will have in this account. The insurance company will also invest the money in the account, so it will grow over time.
You have the option to take out the cash value whenever you want. When you do so, you can make a straight withdrawal or take loans from the cash value. Both options let you tap into extra cash during retirement that you can use to cover your bills, as an emergency fund or to save for future long-term care expenses.
What Are the Advantages of a LIRP?
A life insurance retirement plan offers tax benefits similar to those that come with saving through a Roth IRA or Roth 401(k). As long as you keep your cash value growth in the account, you won't owe taxes on the gains. This can boost your after-tax return compared to a regular brokerage or bank account, which would require you to pay taxes each year.
If you take out your cash value gains in retirement through a loan, you get to take out the money without owing tax. You can plan not to pay back the loan, with the idea being that the future life insurance death benefit would pay off the outstanding balance. Since life insurance death benefits are income tax-free, with this strategy you can avoid owing income tax on your gains.
Another advantage of these plans is that there is no limit to how much you can save per year, whereas an IRA or 401(k) will have annual contribution limits. You can also start taking money out of a LIRP at any age, whereas an IRA would require you to wait until you are at least 59 and a half to make retirement withdrawals.
What Are the Downsides of a LIRP?
To use these plans, you must pass medical underwriting and qualify for life insurance, which isn't guaranteed. Of course, you're also paying for life insurance coverage, so not all of your payments would go toward savings. This can be frustrating if you don't end up needing insurance protection.
Taking money out of your cash value in retirement also reduces the future death benefit payment. The more you take out for yourself, the less you leave for your heirs.
When Do These Plans Make Sense?
A LIRP can make sense if you need life insurance, as it lets you tackle two goals at once: saving for retirement and getting insurance protection. It's also a useful strategy if you've maxed out your other retirement plans and are seeking another way to build wealth with tax benefits.
This strategy tends to make more sense for people who are in good health. The price of the policy and whether you qualify for life insurance will depend on your age and health. Those with preexisting health conditions may need to pay more for the coverage, which means less would go toward the cash value. On the other hand, people in good health could qualify for a discount that would allow them to build cash value more quickly.
How Do You Sign Up for a LIRP?
If you'd like a life insurance retirement plan, reach out to a life insurance agent for more information. They can run an estimate for you based on your age, your health and the amount you'd like to save per year. This estimate can forecast how much cash value you'd be building for your future retirement with a LIRP.
If you're happy with this quote, you can formally apply for a life insurance policy by going through medical underwriting. The insurer would then give you their formal offer, which you can accept to launch your LIRP.