In my recently released book “Look Before You LIRP,” I make the case that starting a life insurance retirement plan is a long-term proposition, and not a decision to be undertaken haphazardly. In fact, finding the right LIRP is remarkably similar to finding the right spouse.
There’s a good chance that you didn’t marry your spouse after the first date. In fact, you likely had a laundry list of things you were looking for in the right partner. I would make the case that you should likewise have a laundry list of things you’re looking for in the right LIRP. After all, all LIRPs are not created equal. You must “look before you LIRP!”
In my book, I also argue that finding a LIRP with the right loan provision should be at the very top of your laundry list of qualities. Why? Well, all LIRPs are tax-free, when the money is taken out by way of a policy loan, because loans aren’t construed as taxable income. But, not all LIRPs are cost-free. To understand why, let’s take a look at the mechanics of a policy loan.
Taking a tax-free distribution from your LIRP might work in the following way. You call up your life insurance company and say, “I want to take a $10,000 loan from my policy.” The company then takes $10,000 out of your cash value and they put it in what is called a “loan collateral account.”
It’s important to note that your loan collateral account is still a part of your policy. In other words, the money never leaves your “bucket.” That loan collateral account bears a rate of interest, in this case we’ll say 3 percent. In the very same breath, the company cuts you a check for $10,000 from their own coffers, and that’s what you receive in the mail in 3 to 5 business days. In order for the loan to be an arm’s length transaction per the IRS, the life insurance company must charge you a rate of interest. In this case, we’ll say 3 percent.
Life insurance companies don’t follow a template when designing their loan provisions. (Photo: iStock)