Life Insurance Retirement Plans: The Third Leg of the Stool You May Not Know About Yet

Most people have a few different retirement accounts that are in essentially two buckets: tax-deferred vehicles like IRAs, 401(k)s or even a pension  and taxable investments in a brokerage or savings account.

Many don’t know about the third leg of that stool: a Life Insurance Retirement Plan (LIRP). This is another option that can generate consistent income without a taxable event or capital gains. This would be a tax-free bucket.

You may have life insurance, which is designed strictly to pay your family upon your death for things like debt, tuition and living expenses. For those who are cash heavy, however, a life insurance retirement plan can help augment your existing accounts and allow you to be more tax conscious in how you use them.

To decide if a life insurance retirement plan is right for you, consider the process and upfront costs. First, speak to your financial advisor and shop for the best options with insurance carriers. A LIRP can be funded two ways: either with a single, large premium or periodic payments, typically over 10 or 15 years. The amounts involved are large. A premium of $250,000 or more is typical, and they can go much higher.

Regardless of how you pay, you will quickly build up a significant nest egg that can be pegged to an index like the S&P 500 or Russell 2000. Over time, with growth in the index, your cash value grows without any annual taxable event, and it comes back to you tax-free. The earlier you get started and the longer you leave it, the more you’re likely to have in retirement.

But it’s a life insurance policy. How can you draw funds from it like a bank account? And how is it tax-free?

This is the magic of a life insurance retirement plan. Instead of drawing directly from the policy, you draw from a line of credit based on how much the policy is worth or you draw from the policy itself. Credit draws are tax-free because they aren’t income; they’re a loan or a return of principal.

The effect for you is the same: predictable revenue for most or all of your retirement. As long as one dollar of equity remains in the policy, you can continue to draw.

When it’s time to pay it off, the insurance account can be liquidated to cover any potential outstanding loan value, or the insurance remaining can pay it off at the owner’s passing.

My clients most often start at the peak of their earning power, mid-life, when they have the kind of cash it takes to fund a LIRP. If they’ve paid off their home, finished paying school tuition and are at the height of their career, they have a good deal of extra money they can put away for later. When they’ve finished funding it, they can redirect to more traditional investment vehicles.

At retirement, they use the fund to replace their income stream after employment income and any deferred compensation have ended. Doing it early makes it useful as a tool for delaying big taxable events until later in life. If retirees can draw from the life insurance retirement plan for the first 15 years of retirement, for example, they can put off the taxes associated with capital gains and delay cashing in an IRA for as long as necessary.

Timed correctly, they could even delay taxable events until the laws governing such taxes are more favorable. Given the size of the pendulum swings in Washington from one administration to another, the difference could be significant.  A life insurance retirement plan gives the high-income earner a lot of options.

Each plan should come with three main components:

• the accumulation of cash value
• a death benefit (with a lowered cost of insurance)
• flexible premium funding

Most retirement plans are straightforward and, if we’re being honest, a little boring. Life insurance retirement plans can help you be a lot more creative. If you can bear the heavy upfront costs and keep an eye on the long game, they can play a central role in your future income or even be a great way to pass along generational wealth.

Haskell Shelton is a financial advisor based at Pinnacle’s Green Valley office in Greensboro, NC. He can be reached by phone at (336) 881-3226 or by email at Haskell.Shelton@pnfp.com.