What this article covers
A Life Insurance Retirement Plan (LIRP) is a permanent life insurance policy funded above its required premiums so the cash value can be borrowed against for tax-advantaged retirement income. Opher Ganel explains how cash value and policy loans work, lays out the pros and cons against a 401(k) or IRA, and argues that most people are better off with term insurance plus maxed-out retirement accounts. Two financial advisors weigh in on who LIRPs suit and what the indexed universal life sales pitch tends to leave out.
Key Takeaways
A LIRP is an overfunded permanent life insurance policy, not a formal retirement account
Any permanent policy with cash value can serve as a LIRP when you pay in more than the required premiums to build that value faster. In retirement you can typically borrow up to about 90% of the cash value, and loans or withdrawals that don’t exceed what you paid in can provide tax-free income. Outstanding loans plus interest are repaid from the cash value or death benefit when you die.
For most people, maxing out a 401(k) and IRA beats a LIRP
Workplace plans and IRAs offer tax-deferred or tax-free growth, possible employer matches, wider investment choices and typically higher returns than any life insurance policy. LIRPs are funded with after-tax dollars, can carry high fees and surrender charges, and permanent premiums typically run 5 to 15 times those of term coverage with the same death benefit.
A LIRP makes the most sense for people who already max out every tax-advantaged account and need permanent coverage
The case is strongest if you already max out 401(k), 403(b), 457(b), IRA and possibly HSA contributions, start young, and need lifelong coverage, for example to provide for a disabled child. Jorey Bernstein says LIRPs can suit business owners and clients leaving tax-free money to heirs, while Jeremy Keil warns that indexed universal life pitches of market-like returns rarely mention missing dividends, commissions, fees and surrender penalties.
Jeremy KeilIf you’ve ever thought of life insurance, it was probably colored by the instinctive unease of thinking about your mortality – the fact that one day you’ll no longer be among the living.
After all, that’s the main reason to buy life insurance – making sure that your passing, as traumatic an emotional loss as it’s likely to be for your loved ones, won’t also be a financial catastrophe.
There are many financial responsibilities life insurance can help cover:
- Replacing income: With you gone, a significant part of your family’s income will likely also go away.
- Paying off debts: Paying a mortgage, student loans, auto loans, credit card balances, etc., likely makes up a large part of your family’s budget. Paying these off reduces ongoing income needs.
- Succession planning for a business: If you’re a key person in a business, life insurance can provide capital to mitigate problems caused by your passing, e.g., hiring a (possibly higher-cost) replacement.
- Compensating heirs: If your estate comprises assets difficult to split equally, especially if your heirs don’t get along, life insurance can compensate those who don’t get a fair share of such assets.
- Estate taxes: If your estate is large enough to trigger estate taxes, especially if it comprises mostly illiquid assets (e.g., real estate and/or businesses), a death benefit can cover estate taxes without forced selling of assets at a difficult and potentially inopportune time.
- Funeral expenses: Your passing will likely be traumatic for those you leave behind. Covering the significant expenses of your funeral and burial avoids making a terrible time even worse.
- College expenses: If you have young children and haven’t set aside enough to cover the full cost of college attendance, life insurance can let them attend their preferred schools.
- Charitable giving: If you’re keen on leaving a larger bequest for a charity or your alma mater than your estate allows, a life insurance policy can make that possible.
However, life insurance policies can also help in a variety of ways while you’re still alive, including:
- Long-term care (LTC): If you lose your ability to carry out for yourself two or more of the six so-called Activities of Daily Living (ADLs: bathing, eating, dressing, transferring (e.g., in/out of bed/chair), continence, and toileting), you’ll need expensive help with these. LTC coverage is often available as a rider on life insurance policies (increasing premiums).
- Loan collateral: Some policies can be used to secure loans that would otherwise be more expensive or not available.
- Access to loans: Permanent (not term) life insurance policies typically have a “cash value” associated with them that can be borrowed from.
- Tax-free retirement income: This is what Life Insurance Retirement Plans (LIRPs) are all about, as explained below.
What Is a LIRP (Life Insurance Retirement Plan)?
Any permanent life insurance policy with a cash value component that will help fund your retirement serves as a LIRP. Since you can borrow or withdraw from the policy’s cash value after age 59½ with no taxes owed except on gains, LIRPs have many of the tax benefits of a Roth IRA. Since term life policies have no cash value, they cannot be LIRPs.
With a LIRP, you pay in more than the required policy premiums, thereby building your cash value faster. Letting that value grow until retirement lets the LIRP be used as part of your retirement planning. LIRPs aren’t formally retirement plans in a legal sense. However, they can serve a similar purpose with similar tax benefits.
How Does Cash Value Work in a Permanent Life Insurance Policy?
As mentioned above, the part of each permanent life insurance policy’s premium payment exceeding what’s needed to cover your death benefit builds up the policy’s cash value – a sort of tax-deferred savings account under your name and linked to the policy. Your policy type determines how returns on that value are calculated.
This may be a set fixed interest rate, or a variable return linked to a market-based index such as the S&P 500, albeit with a ceiling above which returns go to the insurer and a floor that preserves your principal.
The cash value is usually used to pay your premium for you (once it’s high enough) and/or to increase the death benefit. However, once it reaches an amount set by your policy, you can withdraw and/or borrow against a portion of your cash value (typically up to 90%). As long as the withdrawals and/or loans aren’t more than the amounts you paid into your cash value, these withdrawals/loans can provide tax-free retirement income.
One caveat is that if you borrow and die before paying it back, this will decrease the death benefit to your beneficiaries.
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How Do You Use a LIRP for Tax-Free Retirement Income?
First, you build up a large cash value by over-funding your policy.
Then, once you retire, you borrow against (typically up to 90% of) the cash value that built up over your working career. As long as you don’t exceed the policy’s limit, you can borrow any amount(s) you want whenever you want.
For example, if you spend more than your Social Security benefits, portfolio returns, and/or other income sources will cover, you can borrow from your LIRP as needed to cover the gap (e.g., monthly, annually, or periodically). This can be especially helpful if you want to avoid selling shares at depressed prices during a market crash. Then, when the market recovers, you can use excess portfolio returns to pay back the LIRP loans.
Once you die, the insurer will first repay itself for any outstanding balances and accrued interest from the policy’s cash value. If that’s not enough, they’ll take the rest out of the death benefit before paying it out to your beneficiaries.
What Are the Pros and Cons of a LIRP?
As with all things, LIRPs have both pros and cons or limitations, summarized in the following table.
Is a LIRP Better Than a 401(k) or IRA?
401(k) plans and IRAs have significant advantages for funding your retirement. These include tax benefits (tax-deferred traditional accounts or tax-free growth for Roth accounts) and possible employer matching contributions for 401(k) plans.
LIRPs, on the other hand, are funded with after-tax dollars like a Roth, but earnings are tax-deferred like in a traditional retirement plan, offering the worst of the two – traditional and Roth.
These dedicated retirement plans also typically offer a wide variety of investment options, and many have far higher average annual returns than offered by any life insurance policy.
For these reasons, most people would be better off maxing out contributions to their 401(k) and/or IRA before considering putting money into a LIRP.
When Does a LIRP Make Sense, and Who Is It For?
The situation that makes a LIRP most beneficial is if you’re already maxing out all tax-advantaged retirement plans available to you, e.g., 401(k)/403(b)/457(b) plans, IRAs, and possibly Health Savings Accounts (HSAs), but want a higher income in retirement than those will allow.
The younger you are, the lower life insurance premiums become for the same death benefit, making LIRPs less expensive.
If you expect to need to provide for your beneficiaries more than your estate will allow regardless of your age at death (e.g., you have one or more disabled children), that makes the case for the LIRP even more compelling since you need a permanent life insurance policy.
This is not the case for most people whose financial obligations and responsibilities decrease over the years as they pay off their mortgage and other debts, their children become independent adults, and their portfolio may grow enough to cover their widow(er)’s needs.
Jorey Bernstein, Executive Director, Wealth Manager, and Founder, Bernstein Investment Consultants, agrees:
A LIRP can be valuable to a client’s retirement portfolio when used appropriately. These policies let you save for retirement in a tax-advantaged way while also providing life insurance protection. LIRPs make the most sense for clients who maximize contributions to standard retirement accounts, own a business, or want to diversify their assets and leave tax-free money to heirs. However, LIRPs have higher fees and less liquidity than other investment vehicles. We always analyze a client’s full financial picture when making recommendations. For the right investor, LIRP can provide supplemental funds to help meet retirement income goals.
What Are the Alternatives to a LIRP?
Assuming you need life insurance and recognize the need to fund your eventual retirement, and unless you fall into the above-mentioned category of people who’d benefit most from a LIRP, your best alternative is likely to buy term life insurance coverage and invest as much as you can in tax-advantaged plans like an IRA and/or 401(k), especially to capture your employer’s full contribution match. Note that the Roth versions are better than traditional accounts for most.
If you want to invest more than the contribution limits allow, consider low-cost deferred annuities and/or tax-efficient investing through a taxable account as alternatives to the LIRP.
Aside from their lower premiums, term policies, as their name implies, have a set term; they can also be dropped without surrender charges or other complications that often arise when canceling permanent life insurance policies.
The Bottom Line: Is a LIRP Right for You?
LIRPs are far more complicated than 401(k) plans and IRAs and come with a raft of pros and cons (see the table above).
For some people, LIRPs provide a good way to set aside more money for tax-deferred growth than formal retirement accounts allow. LIRPs can provide guaranteed interest or variable index-linked returns with a floor that secures their principal and a ceiling beyond which the insurer takes excess returns.
This is especially helpful for people who also expect to always need insurance to provide for beneficiaries such as disabled children who cannot fend for themselves, even as adults.
For most of us, it’s better to buy the right amount of term life insurance only for as long as the death benefit will be needed and invest as much as we can in our 401(k) plans and IRAs. Although contributions to these are limited by the IRS, most people can rarely max those contributions.
And if you don’t expect to need permanent life insurance, even if you regularly max out your formal retirement plans, you may be better served by a tax-efficient taxable portfolio and/or deferred annuities than a LIRP.
Finally, since LIRPs are insurance policies and come with a host of complexities and costs, consult your financial advisor and life insurance agent before making such a major decision.
As Jeremy Keil, CFP, CFA, Financial Planner with Keil Financial Partners, says:
Cash-value life insurance may make sense as an alternative to bonds or CDs since the insurer generally invests in bonds so returns are usually bond-like. Often with LIRPs, the salesperson will tell you that you get ‘market-like returns’ with no chance of losing money. For some reason, they rarely mention the fact that you don’t get dividends from an indexed universal life policy, or that there are commissions, costs, fees, and surrender penalties for exiting the contract. Before buying life insurance, especially an indexed universal policy, do some research, e.g., through theiulexperiment.com and perhaps hire a fee-only insurance advisor to help you make the right decision.
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Frequently Asked Questions
What is a Life Insurance Retirement Plan (LIRP)?
A LIRP is any permanent life insurance policy with a cash value component that you use to help fund retirement. You pay in more than the required premiums to build cash value faster, then borrow against it in retirement. LIRPs aren’t legally retirement plans, but they can serve a similar purpose with similar tax benefits. Term life policies have no cash value, so they can’t be LIRPs.
How do you get money out of a LIRP in retirement?
Once the cash value reaches the amount your policy sets, you can withdraw or borrow against a portion of it, typically up to 90%. As long as withdrawals and loans don’t exceed what you paid into the cash value, they can provide tax-free income. Any loan balance and accrued interest left at death is repaid from the cash value and then the death benefit before your beneficiaries are paid.
Is a LIRP better than a 401(k) or IRA?
For most people, no. 401(k) plans and IRAs offer tax benefits, possible employer matching, a wide range of investments and typically higher returns than life insurance. The article recommends maxing out 401(k) and IRA contributions before considering a LIRP.
Who should consider a LIRP?
A LIRP is most beneficial if you already max out all your tax-advantaged retirement plans but want more retirement income than they allow. It is cheaper the younger you start, and the case is even stronger if you need permanent coverage, such as to provide for a disabled child. One advisor interviewed added business owners and people who want to leave tax-free money to heirs.
What are the alternatives to a LIRP?
For most people, the better path is buying term life insurance for as long as it’s needed and investing as much as possible in a 401(k) and IRA, capturing any full employer match. If you want to save beyond contribution limits, low-cost deferred annuities and tax-efficient investing in a taxable account are alternatives.
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Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.
About the author
Contributing Writer, Wealthtender
My career has taken some unexpected turns, from earning a PhD in experimental high-energy physics, to conducting cosmic-ray research in Antarctica, to supporting NASA projects and programs, to running my own consulting business. I also run several other small businesses and help my wife run her Marriage and Family Therapy practice.
Those experiences taught me to question assumptions, think critically, and recognize that real-world decisions of any significance rarely have simple answers that apply to everyone. Today, I bring that perspective to writing about personal finance. Drawing on my analytical background, business experience, and research, I explore financial decisions, challenge conventional wisdom, and help readers understand the tradeoffs that can affect their financial well-being. To complement my own research and experience, I also weave insights from financial professionals into my articles, drawing on their expertise and real-world experience helping clients navigate financial decisions and challenges.
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