Can life insurance revitalize your high-net worth clients’ retirement plans?
Tax-advantaged retirement plans such as IRAs and 401(k)s are great for middle-class employees, but low contribution limits circumscribe their value for high-net-worth executives and entrepreneurs. If the $49,000 ($50,000 for 2012) annual contribution limit for 401(k) solos and SEPs is not enough to satisfy your client’s retirement objectives, what is the next step?
Enter life insurance retirement plans (LIRPs), which offer many of the same advantages and none of the limits of their traditional counterparts. But use of life insurance as a retirement savings vehicle is controversial, so caution is warranted.
A “life insurance retirement plan” is (at least according to some critics) little more than a euphemism for “overfunded variable universal life (VUL) insurance policy.” They are typically sold to high-net-worth investors as a pseudo-Roth replacement vehicle offering long-term, tax-free accumulation of income for supplemental retirement needs. They offer the greatest benefit for investors who have already maximized other tax-advantaged retirement savings plans.
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Retirement cash needs are satisfied from the LIRP via policy loans and withdrawals. Because life insurance is taxed on a first in, first out basis, tax-free withdrawals can be made up to basis. Unless the policy is classified as a modified endowment contract (MEC), loans can be taken cash free.
Contributions to the LIRP will generally need to be made for at least the first 10 years of the policy. Once the cash value of the policy catches up to deposits, loans and withdrawals may be taken.
LIRPs are typically overfunded—amounts over and above premiums are deposited into the policy—with the intention of maximizing cash value and the tax advantage of the policy.
The benefits of overfunding a life insurance policy for supplemental retirement savings are many of the same benefits touted for life insurance policies in general: (1) tax deferred accumulation; (2) asset protection; (3) the availability of disability waivers; and (4) penalty-free distributions prior to age 59½. The only limits on contributions to a LIRP are the MEC rules.