Investing for retirement means choosing among a range of well-known options — traditional individual retirement accounts and 401(k)s, the Roth variety of each, plus ordinary taxable investments. But there are some less well-known opportunities, too, like the life insurance retirement plan, or LIRP.
If you haven’t heard of these, it may be because you aren’t rich enough, as LIRPs have mainly appealed to people in high tax brackets.
But people of ordinary means can use a LIRP to prepare for a more secure and prosperous retirement, many experts say, though the well-to-do get the most out of them.
“A LIRP is ideal for anyone who wants to avoid the restrictions common to traditional retirement plans, and is concerned about market volatility and wants guaranteed, predictable growth, and to avoid losing money in a market crash,” says Pamela Yellen, founder of BankOnYourself.com, a personal finance website. “People who tend to live above their means and don’t have patience or self-discipline should avoid LIRPs, as they are a long-term strategy.”
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“If built, maintained, and managed properly, LIRPs can provide amazing benefits to individuals seeking tax-free sources of retirement income,” says Justin Fort, a financial planner and insurance expert who is president of Fort Wealth Management in Austin, Texas. “However, if a LIRP is poorly built, unmaintained or mismanaged, it can be an amazing source of heartache, stress and loss of value. This is not a set-it-and-forget-it tool like many term life policies or annuity contracts.”
LIRPs use whole or universal-type life insurance policies that provide minimal death benefits and instead emphasize growth in cash value. While people with life insurance policies typically pay only the required premium, those with LIRPs shovel in extra money to build a cash value that is invested for growth to maximize withdrawals in retirement, which are tax free.
Among the key features of LIRPs:
— There is no income limit for opening one of these accounts. That makes them available to people who earn too much to open a Roth IRA.
— There is no limit on annual contributions. This is a major departure from rules on 401(k)s and IRAs, Keoghs, SIMPLE and SEP plans. Contributions, however, are not tax deductible.
— As with Roth accounts, there is no annual tax on investment gains and withdrawals of premiums paid to that point are tax free, as are additional withdrawals of investment gains if taken as loans. In contrast, withdrawals from the more common types of plans like traditional 401(k)s and IRAs are added to taxable income.
— LIRPs have flexible investing options, typically a choice between a fixed return guaranteed by the insurer, or a market-based return from a selection of mutual funds, actively managed and indexed.
— Unlike many retirement accounts, LIRPs have no penalty on withdrawals before 59.5. Policyholders can withdraw at any time so long as the policy stays in force
So, if LIRPs are so wonderful, why do we hear so little about them?
Critics warn that the apparent benefits are often offset by other features like high upfront fees. Another problem is that, like many insurance products other than bare-bones term life, comparison shopping is difficult.
“The most important factor in determining success using LIRP is the contract design — and each different policy will behave differently due to internal cost differences, so each policy needs to be tweaked …. (so) that the cost inefficiencies are removed,” says Bradford D. Creger, president of Total Financial Resource Group of Glendale, California. “In other words, even two different insurance contracts at the same insurance company will behave differently.”
Still, he says a properly designed policy can work well, largely because of the tax savings. He urges clients to put in as much as they can, then after five to 10 years to use cash value to pay future premiums while reducing the death benefit as much as allowed to keep premiums low. He prefers investment options that track indexes like the Standard & Poor’s 500 index.
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Many policies offer guarantees against loss of principal, he adds, though they typically also cap gains at around 12 percent a year. These policies usually work best for people who can wait at least 15 years before starting withdrawals, he says.
Because many policyholders choose to take income in the form of tax-free loans, loan terms are a key consideration, experts say.
“The most important things to look for in a LIRP are an attractive loan arrangement, a good rate (on loans taken out), and projected values and guarantees that meet the needs of the policyholder,” says Bruce Gendein, president of The Senex Group, a specialist in tax-qualified retirement plans in Woodland Hills, California. “And be sure an over-loan protection rider is part of the mix. This is vital to keep the policy from lapsing if policy loans exceed the cash value of the policy. ”
Who should stay away?
Creger says, “The only people who shouldn’t consider using it are older than say 61 or 62 on the date of the first premium payment — unless they have a younger spouse that could benefit from the strategy, and then we put the insurance on (the younger spouse’s) life.”
Of course, the higher you think your tax rate will be in retirement the more you will benefit from tax-free growth.
Because LIRP contributions are not deductible, experts often urge investors not to open a LIRP until they have put the maximum allowed into a plan such as a traditional 401(k) that does provide an upfront deduction.
“The best candidates for this strategy are young, high-income individuals who aren’t able to meet their retirement needs with standard retirement plans due to government-regulated contribution limits,” Gendein says.
Other experts, however, argue that young investors can do better in low-fee stock mutual funds, as the young have plenty of time to ride out market downturns.
“There is no way a LIRP can compete with an index fund such as (one tracking the S&P 500),” says Paul Ruedi, CEO of Ruedi Wealth Management in Champaign, Illinois. “If you need your money before retirement, you can get at (it)… The bottom line is investors should stay clear of such nonsense. The whole idea of LIRPs is to generate huge commissions for agents.”
LIRPs are not designed for do-it-yourself’ers. Though you can shop for simple term life policies online, all insurance is sold through agents, and buying a complex whole or universal life policy meant for a LIRP requires the help of a professional, Fort says.
[See: 8 Things That Matter More Than Money for a Happy Retirement.]
“Most insurance agents are not competent when it comes to the complexity of LIRPs, but would be more than happy to try to sell you one,” he say. “Once you find an insurance professional claiming to be a LIRP specialist, you should ask about their ongoing management services, compensation structure, experience, designations and education. Make sure they are willing to provide multiple quotes or illustrations for your LIRP from multiple highly rated insurance companies.”
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How Ordinary Investors Can Use LIRPs originally appeared on usnews.com
