The main purpose of a life insurance policy is to take care of your loved ones after you die. However, your life insurance policies can also be significant stores of value. In particular, if you hold one for most of your adult life, your policy will typically build up excess cash. Depending on the nature of your policy, you might be able to access that cash to help supplement your retirement. Here’s how it works.
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What Is a Life Insurance Retirement Plan?
A life insurance retirement plan (LIRP) is a permanent life insurance policy that you over-fund over the lifetime of the policy. This builds value in what is known as the plan’s cash account. You can access this money by taking out loans against the account’s balance.
While you can take out loans against your life insurance plan’s cash value at any time, this is particularly known as a form of retirement planning. It can give you access to cash later in life, particularly if you allowed the policy’s cash value to grow over a long period of time.
What Is Life Insurance Cash Value?
With all permanent life insurance plans, there’s a good chance that on any given month you will pay more in premiums than is actuarially necessary to maintain coverage. Whenever that happens the excess is added to what is known as the policy’s “cash value.”
This is an account of cash held in your name and attached to the policy. It grows based on the terms of the policy, with different plans offering different rates of return. For example, some may offer a fixed interest rate while other insurance policies will offer a variable, market-based rate of return.
Except for specific, unusual circumstances, you cannot access the money in your life insurance policy’s cash account directly. Every plan handles this account differently, but most use it as a way to either mitigate premiums later in life or boost the death benefits that your account ultimately pays.
You can also boost the amount in your cash account by overpaying your life insurance premiums at any given time. When you pay more than the minimum amount necessary to maintain your life insurance policy’s coverage the excess payment goes toward your policy’s cash value.
For people who intend to use their life insurance policy as a form of retirement planning, this can be a way to boost its value long term.
How to Use a LIRP
Over-Fund Your Policy
During your working life, you will over-fund your life insurance policy. This will build up principal in the account’s cash value, as well as returns based on the nature of your policy. In policies with a good rate of return, the account can build significant value over its lifetime.
Take Out Loans In Retirement
Permanent life insurance plans allow you to take out loans against the policy up to your account’s cash value. In some cases, you may have a cap near that value, for example, 80% or 90% of your account’s cash value. You can take this money out at any time, in any structure that you want.
For many retirees, then, this is a way of supplementing their retirement. They might take out a fixed loan every year, or every month, as a form of household income.
Repay The Loan With Your Policy
The money you take out of a life insurance retirement plan is technically a loan, which means it will include an interest rate. If you do not repay this loan by the policy’s end, your insurance company will take payment first from the cash account. If that is not enough to cover the balance, it will deduct the rest from your policy’s benefits.
This allows you to repay your LIRP loan, effectively, as a form of estate planning. At the time of your death, as long as your loan plus interest is less than the cash value of your insurance policy, your insurance company will simply collect the money from your policy and then pay out the policy’s death benefits to your beneficiaries.
Limits and Benefits of a LIRP
The main benefit of a LIRP is that you receive the money tax-free. When you take money from a life insurance retirement plan it is a loan, not a withdrawal. This means that the Internal Revenue Service (IRS) does not consider it taxable income.
The upshot is that not only can you access this money tax-free, but you can use it to manage your overall tax planning. For example, in any given year you can reduce your withdrawals from other accounts and boost your income from a LIRP to change your total tax status.
In other words, if you take out $10,000 you will get $10,000. This allows a LIRP to function as a form of Roth retirement account in some ways since you will get both investment-based gains and a tax-free return.
However, there are some downsides to this system. Specifically, that this is a loan. The tax-free benefit of a LIRP is somewhat reduced by the fact that your insurance company will charge you interest. This means that the total value of your account is functionally reduced by whatever interest payments you’ll need to make. In other words, if you have $100,000 in your account, you may only have $90,000 that you can use.
However, this is not always the case. Some insurance companies offer what is called a zero-cost loan, in which case you will effectively not have to pay interest on the loan you take from your LIRP. However, it’s critical to check on this before setting up an account.
A LIRP can be a very useful tool for investors who want a secure place to store money, but it comes with some fairly expensive downsides. In general, it’s best to maximize your tax-advantaged savings accounts first. Then, if you want a permanent life insurance policy anyway, add some additional money to your existing premiums. This can be a good supplement to your retirement planning, but it should not be your first line of defense.
Insurance Planning Tips
- Your selection of an insurance policy can have lasting effects on your overall finances, especially once you reach retirement. If you’re unsure of which policy to go with, a financial advisor may be able to help. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Financial planning is vital for achieving your goals for your future. Life insurance can be a major part of these plans, in addition to investing and other financial strategies. Use SmartAsset’s guide to creating a financial plan to learn more.
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