Most people agree that life insurance is preparation for the unthinkable. It certainly is, but it can be more than that — in fact, you can use life insurance as part of your retirement income plan.
Some policies, known as permanent insurance policies, have an investment component that can build cash value. With these policies, you can effectively become your own bank, dishing out tax-free paychecks in retirement while never losing money in the market.
Here’s how it works.
(Over)Fund Your Future
A Life Insurance Retirement Plan (LIRP) uses the cash value in life insurance to fund tax-free withdrawals and loans that serve as income during retirement. LIRPs require over-funding life insurance policies, meaning you pay more than the premium amount, to adequately fund your future income. As such, a LIRP strategy usually works best over time.
While different than the traditional 401(k) and individual retirement accounts (IRAs) usually associated with retirement saving, LIRPs provide unique benefits for retirees.
First and foremost is investment safety. LIRPs are structured so you can never earn less than 0 percent. While it’s true that you won’t earn big in boom years, more importantly, you won’t lose in bad markets, like back in 2008.
LIRPs also help keep your tax liability low and provide protection against rising future rates.
See with life insurance, you’re not taxed on withdrawals equal to the amount of money you’ve put in the policy. And you can take tax-free loans against the policy’s cash value. This setup enables you to drive down your taxable income in retirement.
Another obvious benefit of life insurance is it provides a death benefit to your loved ones. Keep in mind though, the death benefit is net of any loans against the policy.
A less-obvious benefit of life insurance is protection against costly long-term care via “accelerated death benefits” for terminally ill policyholders. While not a primary reason to obtain coverage, protecting your assets from costly care is valuable to your retirement plan.
Proper Fit a Must
While the idea of using insurance for protection and income may sound enticing, it’s important to understand that LIRPs aren’t for everyone.
In general, if you aren’t hitting contribution limits on your 401(k) and IRA plans, start there first to maximize tax advantages and matching employer contributions. Similarly, if you’re at a point in life where you don’t need life insurance, there are probably better strategies than a LIRP for your money.
But if life insurance is a need and you’re already contributing all you can to other retirement accounts, a LIRP can work well to generate tax-free retirement income. Since there are no contribution limits with permanent life insurance, it’s possible to build up quite an income base. However, it’s critical to manage the policy so it doesn’t become a modified endowment contract and lose its tax-favored status.
Making a LIRP Work
Ron, an engineer, and Nancy, a pediatrician, are both 65 years old and newly retired after successful careers. They plan to withdraw $75,000 annually from their 401(k) and IRA accounts, supplementing that with $25,000 per year from Social Security, to live on a total of $100,000 per year in retirement.
Sounds great, right? It follows the “conventional wisdom” so prevalent today.
But there’s a problem.
As it stands, all their retirement income is all taxable. And like most people, they want to be in a lower tax bracket while retired so their money stays theirs.
If Ron and Nancy had a LIRP, that $75,000 portion of their annual retirement income could come from life insurance instead of taxable retirement accounts. This would make their taxable annual income $25,000 (from Social Security), rather than $100,000.
In other words, they’d pay much less to Uncle Sam every year.
Beyond the Traditional
If it fits into your situation, a LIRP can offer several benefits to your retirement that aren’t available with “traditional” retirement planning — safety from market volatility, tax-free income and more.
But again, LIRPs aren’t for everyone. They make sense in the right situation. To see if a LIRP can fit into your retirement plan, seek help from a qualified insurance professional.
A trusted professional can help craft the right strategy for your situation and sort through potential solutions. Plus, they’ll be there in the future to help manage the policy so you can be confident in your retirement income, no matter the state of the markets.
Holly Peterson is the owner of Elite Retirement Strategies and a former radio show host. You can find her online at eliteretirementstrategies.com or by calling 208-252-4345.