Americans are watching with a growing sense of dread as our nation’s debt levels continue to spiral out of control. In just 15 short years, we’ve gone from budget surpluses to more than $15 trillion of debt. What’s worse, the federal government doesn’t show any signs of righting the ship.
Today, the federal government spends 76% of the federal budget on just four things: Medicare, Medicaid, Social Security and interest on the national debt. Absent serious efforts on the part of Congress, those costs are set to climb to 92% of the federal budget by the year 2020.1
This huge increase will be fueled in large part by the exodus of our nation’s 78 million baby boomers out of the work force and on to the rolls of our entitlement programs. In order to offset these costs, tax rates would have to rise dramatically.2 In fact, David Walker, a former federal comptroller general, has calculated that taxes would have to double immediately in order to sustain our ever-increasing debt load.3
In response to these dire warnings, many Americans have turned to tax-free accumulation tools as a means of protecting their retirement assets from the impact of rising taxes. For many, a well-balanced approach to tax-free retirement planning may include the use of a life insurance retirement plan, or L.I.R.P.
Take our quiz: L.I.R.P. or Roth IRA — Which is Better For Your Client?
The L.I.R.P. advantage
A L.I.R.P. is an accumulation tool that shares many of the tax-free attributes of traditional retirement accounts, such as the Roth IRA. Not only are distributions 100% tax-free, but they also do not contribute to the income thresholds that trigger the taxation of Social Security. When utilized properly, the L.I.R.P. has additional attributes that make it a surprisingly attractive alternative for tax-free retirement accumulation.
No income restrictions: When I meet with clients, I often ask them, “Can Bill Gates contribute to a Roth IRA?” The answer, of course, is no. His income far exceeds the $173,000 threshold at which Roth IRA contributions are phased out. I then ask, “Can my children contribute to Roth IRAs?” The answer, again, is no. In order to contribute to a Roth IRA, you have to have earned income. My kids work; I just don’t pay them! For clients who either earn too much or lack the necessary earned income to contribute to a Roth IRA (e.g., retirees), the L.I.R.P. can be a powerful alternative.
No contribution limits: Currently, the IRS restricts the amounts that can be contributed to tax-free accumulation accounts, such as the Roth IRA. In 2012, those who are under age 50 can contribute $5,000 per year, while those over 50 can contribute $6,000 per year. There are no such limitations with the L.I.R.P. For clients who are looking to reposition highly taxable assets into tax-free accounts but feel limited by the contribution limits of the Roth IRA, the L.I.R.P. can help.
No legislative risk: Because tax-free accounts cost the government billions of dollars per year, they are an ever-growing target for revenue-hungry legislators. If history serves as a model, however, the L.I.R.P. will likely be immune to the impact of tax law changes. When Congress changed the rules on the L.I.R.P. in 1982, 1984 and 1987, existing L.I.R.P. arrangements continued to be taxed under the old laws. Such grandfather clauses give the L.I.R.P. a much longer shelf-life than traditional tax-free alternatives.