Does it concern you that your retirement income could be severely impacted by your tax liability when you retire?
With the amount of debt owed by the US government (taxpayers), do you really believe that you’ll pay a lower tax rate on retirement income?
Are you being told that as long as you take 4% or less from your retirement account each year, you’ll be just fine?
Are you concerned that your investment advisor is more concerned about wealth accumulation rather than wealth distribution?
These types of questions are typically the result of researching the best retirement planning methods. Research is time well spent, but what happens when you find conflicting articles about retirement planning?
Here, we’ll address these questions and more by considering the LIRP; IUL or Whole Life?
What is a Life Insurance Retirement Plan (LIRP)?
A LIRP is simply a retirement planning strategy that is somewhat outside the box of traditional retirement products we’re all accustomed to.
Since it is constructed using life insurance, your LIRP is immune to all of the draconian rules and limits that have been placed on traditional retirement products by tax-hungry legislators.
A LIRP is not affected by contribution limits, early withdrawal penalties and taxes, minimum required distributions, nor will it have an impact on social security retirement income.
But… but… but a LIRP is life insurance you may be thinking. Yes, it is. Read the previous three sentences again, please.
Which kind of life insurance should I use in my LIRP?
Well, first of all, it certainly must be cash-value life insurance and, it must be permanent. You certainly can’t get cash from a policy without cash value, and your policy certainly must live as long as you will.
There are two types of life insurance that will work with a LIRP; universal life insurance (the kind that is indexed) and whole life insurance (we recommend the 10 pay plan).
Regretfully, you’ll find as many people favoring indexed universal life as you will that favor whole life (only participating whole life). Certainly, this can lead to more confusion until you fully understand how each type of policy works but more importantly the power of uninterrupted compound interest.
Indexed Universal Life versus Whole Life Insurance
Using Indexed Universal Life Insurance (IUL) is a great strategy for wealth accumulation because although every policy contains an annual earnings limit, the policy also contains a minimum earnings limit as well.
The IUL earns interest by linking the cash account to the performance of market indexes you select. Unlike variable universal life, the cash in your IUL cash account is not directly invested in the index accounts but rather linked to the performance of the accounts.
This method allows the policyholder (investor) to earn interest in the stock market but not assume the risks of being in the stock market. Unfortunately, your policy will have a throttle that is controlled by the cap rate.
For example, if an index reports a 16% earning but your policy is capped at 12%, the most you’ll earn will be 12%. And, forget about dividends because the insurer will keep them.
Thankfully, however, the cap rate is offset by the floor rate. This means if your index suffers a loss during a reporting period, that loss is not charged against your cash account because your floor rate will be 0% or even more in some cases.
The most important thing that your insurance agent can advise if you decide on an IUL policy for your LIRP is to only select the minimum amount of death benefit allowed. Doing so will ensure that the majority of your premium payments (contributions) will go towards the cash account rather than spent on the cost of life insurance.
If you need a lot of life insurance for income replacement, debts, or college funding, buy term life insurance. Term is a temporary policy for temporary needs and it’s awfully cheap compared to any other type of life insurance.
Whole Life Insurance purchased from a mutual company can accomplish the wealth creation you’re looking for similarly as indexed universal life insurance but in a different manner.
Where the IUL earns interest based on the performance of your indexes (without the benefit of dividends), whole life insurance earns interest based on the performance of the insurance company (a minimum amount is stated in the contract) and dividends are generally earned year after year.
As with indexed universal life, the investor should focus more on wealth accumulation than a death benefit so as much premium as possible will go to the cash account (use term, it’s cheaper).
Which life insurance policy should I use to fund my LIRP?
Since both IUL and Whole Life insurance will accumulate the wealth you’ll need for retirement income, we’ll need to point out each product’s similarities and differences to determine which product will act as the better retirement vehicle.
- Both insurance products will provide a death benefit and a cash value account that earns interest.
- Both insurance products provide lifetime coverage as long as the appropriate premium is paid.
- Both products earn interest that is tax-deferred.
- Both products allow the policyholder to withdraw funds via tax-free policy loans.
- Both products will pay a tax-free death benefit to beneficiaries.
- Both products typically include an Accelerated Death Benefit rider that allows the policyholder to withdraw (tax-free) a large portion of the death benefit if diagnosed with serious health issues or need healthcare on a long-term basis.
- The IUL product will earn a higher interest rate than the whole life product.
- There will be years when the IUL may earn a low amount or no interest whereas the whole life product is guaranteed the same amount every year.
- The Whole Life product will earn dividends whereas the IUL cannot.
- Once issued, the minimum premium and death benefit of the whole life policy is etched-in-stone whereas the IUL premium and death benefit are flexible.
Since there are more similarities than differences – which product should I choose?
The answer to this question is not a conundrum but rather fairly simple. The most important aspect of accumulating wealth over time is the power of compounding interest. However, to accumulate enough cash so that the policyholder will not outlive the desired income stream, the compounding must not be interrupted.
With an Indexed Universal Life policy that is not set up on fixed interest (3-5% annually) but is setup using the indexing strategy, there will be years during the life of the policy where the account will earn either very low interest or no interest thus interrupting the compounding of the interest.
With Whole Life Insurance, this compounding interest interruption never occurs because the interest rate is guaranteed by the insurance company and the policy will earn dividends as well.
Certainly, there is more to discuss when considering a LIRP for retirement planning and that is something we will do in future articles. Here, we’ve discussed which life insurance product will accumulate the wealth you need for retirement. Going forward we’ll discuss how a LIRP provides tax-free retirement and will allow the policyholder to even stop filing a tax return when you get to retirement. Stay tuned…