THE FISCAL BLUE PRINT
WITH COACH JEFF MONTGOMERY
Episode 15: Taxes in Retirement- Look before you LIRP!
In this 4-part series on taxes in retirement we have been highlighting the concepts of Author David McKnight’s best-selling book titled “The Power of Zero.” If you read that book, many of you were probably the least familiar with the LIRP. The LIRP is a retirement tool that merits a thorough screening. It’s often sold as an end all, be all perfect retirement tool. For some it works well and for others it makes no sense whatsoever (in my humble opinion.)
On today’s show, we’re going to do a deep dive on this retirement tool, explain the basics, go over some of the things to look for and some of the things to avoid when thinking about adding this as part of your overall retirement income strategy.
Disclaimer: Please do not take advice from me on this show. As a licensed Fiduciary I am only allowed to give advice to clients. Unless you’re a client I can’t give you advice because I don’t know you. Think of this as helpful hints and education only! And please, before implementing any information or ideas you hear on this show always consult your legal adviser, your tax adviser, and your financial adviser.
(2:00) Practical Planning Segment: Today we are taking a deeper look at the retirement planning tool commonly referred to the LIRP, which stands for the Life Insurance Retirement Plan.
As a follow up to the book titled The Power of Zero, the author David McKnight wrote, “Look before you LIRP.” Again, I think he did a really good job of explaining this tool and highlighting the pros and cons of these products and what to really look for before you purchase one of these. McKnight talks about that if you decide the LIRP makes sense for your retirement income plan you must really think of this a long-term arrangement! In the book he actually compares this to a marriage!”
Just like a marriage, you shouldn’t rush into it blindly or haphazardly. The LIRP is a long-term proposition so in short you must do your due diligence and LOOK before you LIRP!
(4:00) Let’s go over some of the pros of the LIRP:
- No pre-59 ½ penalties like IRAs and ROTH IRAS. Unlike other retirement plans there are no penalties if you take money out before you reach age 59 ½
- No 1099’s. The money in the LIRP’s accumulation account doesn’t get taxed as it grows like funds in the 1st tax bucket would.
- Distributions are not reportable as income if done properly. If you take money out of your LIRP the right way, it’s not reportable as income. Distributions are tax free and it they also don’t count as part of the provisional income or what they now call “combined income.”
- No contribution limits. Unlike the ROTH IRA, the LIRP has no contribution limits. The IRS only requires the amount of the contributions be tied to the amount of the death benefit.
- No Income limits. As mentioned in the last show, the ROTH IRA has income limits for contributions. If your MAGI is too high you are not allowed to contribute to a Roth.
On the surface, it may sound like the perfect retirement tool. However, as I mentioned many times, it may make sense a part of an overall income plan along with your 401k or IRA, the Roth IRA, ROTH IRA conversions… all working together in retirement to get close to a zero percent tax bracket!
(10:30) Some important things to look for IF someone thinks adding this tool makes sense as part of their plan:
- Safe and Productive growth; not enough for the LIRP to be safe. Savings accounts are safe, but they are a terrible way to fund retirement. You’re looking for a plan that can guarantee against market loss while at the same time delivering growth to provide tax free income withdrawals at a later date.
- Low fees; what every you pay the life insurance company in fees obviously does not help your tax-free retirement. It’s very important your LIRP has low fees.
- Tax free and cost-free distributions; every LIRP allows you top take out distributions tax free, but some bad ones charge you for those distributions. So, the good ones have both tax free and cost-free withdrawals.
- Cost free LTC rider; The really good LIRPs also have a cost-free rider to help pay for LTC costs if needed later in life. Of course, they have a DB payable at death, but this would be a benefit that could be used while living IF NEEDED
(13:30) Now that you have your list you can start looking at all the options available. The main differentiating characteristics of LIRPS is how the accumulation (growth of the account) grows over time. There are essentially 3 different options:
- Your CV grows with the investment portfolio of the insurance company; the insurance co assumes 100% of the risk. With that in mind, insurance companies are usually inherently conservative, and the growth rates are pretty low.
- The Stock Market; In variable cash value LIRP’s, you invest your money in sub-accounts which are essentially mutual funds inside the life insurance policy, and you assume 100% of the risk.
- Index; your accumulation account is linked to the growth of an index (SP500). You participate in the growth up to a cap; the insurance company guarantees against loss.
(18:00) All 3 options have one or more of the essential qualities, all 3 may help you get to the 0% tax bracket. But only ONE has all 4 of the essential characteristics I mentioned earlier. It is called indexed universal life or IUL for short. There are many companies that offer these but within each of these, there are other important things to consider. Such as:
- The financial stability of the company; make sure you work with a financially stable insurance co. ‘A-plus’ rated or above when we look for these that make sense for some clients.
- A stable index cap rate; look for a history of the insurance company keeping the cap rates stable.
- Guaranteed 0% loan withdraws; I mentioned earlier as cost-free withdrawals.
- Some type of overloan protection rider included in the policy; You have to have some money remaining in your growth account when you die. If you don’t, you run the risk of the policy lapsing and all your withdrawals becoming taxable. So, the good ones have protection against this ever happening.
(21:30) Let’s go over the basics of how a LIRP can work as part of your overall income plan; the basic idea is you are using life insurance for funding tax free income withdrawals in the future rather than using life insurance for the death benefit. You are essentially turning the traditional idea of life insurance on its head.
Your goal is to grow the cash value of the policy as much as possible in a safe and productive way, keeping fees low by purchasing as little life insurance as possible.
I mentioned earlier the IRS requires you to buy a certain amount if Life Insurance based on the amount of your premium payments. A minimum Death Benefit (DB) if you will. You can’t fund a life insurance policy with a zero Death Benefit, the IRS will not allow that.
On the flip side, the higher the Death Benefit, the higher the fees in the policy. The DB is what the insurance charges fees for and the higher it is the more fees you pay. Remember, one of the characteristics of the ideal LIRP is low fees, so we need to keep the DB as low as possible.
(24:00) The amount of the DB will be determined by how much you want to put into the LIRP each year. There is no contribution limit. So, when you initially set up the LIRP you designate how much you want to invest each year. The Insurance company will then determine the minimum DB required by IRS guidelines.
Full disclosure… I personally have a LIRP as part of my overall plan and many of our clients have them as well.
- The first step in examining this as an option is to decide how much you want to invest on a monthly or yearly basis and for how long.
- Step 2 is to run an illustration from a variety of ‘A’ rated insurance companies that offer a LIRP with all the characteristics we identified earlier. The illustration will give us growth and income projections based on historical index rates. The illustrations are based on historical returns since it is tied to the performance of an index (like the S&P.)
- Based on the growth account projections which are directly related to the amount you invested each year and for how long you invest before you take w/ds, the illustration will show you the yearly amount of w/ds at your desired age. This may be at retirement or later on. (In my case I will start my w/ds at age 70 ½ to correspond with my RMD w/ds at that age.)
(31:30) If all goes well with the plan, then you can possibly create 4 tax free streams of income:
- Limit the size of tax later bucket to keep withdraws under standard deduction size at that time
- Limit the size of the taxed now bucket to emergency funds only
- Create the tax-free bucket with a Roth Ira conversion strategy before age 70 ½ by conversions and/or contributions and Create tax free income with the funding of a LIRP
- If the previous streams of retirement income are all tax free then (unless congress changes the rules) then the final part, SS income, should be tax free as well.
Next week we will go over some of the popular myths regarding LIRPS and well finish up our conversation of doing your best to create a tax-free retirement!
(35:30) Coaching segment: This week’s coaching segment is to order the book by David McKnight titled LOOK before your LIRP. (https://www.lookbeforeyoulirp.com/)
I want you to read the book and come up with some questions for a future show on the LIRP. Our next series after we finish up next week’s episode will be another Q&A series; here are a few ways to send us your questions!
- Simply email them to Jeff personally at Jeff@mfswealth.com.
- Go to our podcast website at www.fiscalblueprint.com and record your question directly through the orange button that says record now. You can record your question and it will be sent directly to us.
- You can of course also give us a call at 855-97-COACH and speak with Kristen and she will take down your question and pass it along.
“We appreciate you joining us today for this episode of The Fiscal Blueprint.
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“Opinions voiced in this recording are for general information only and not intended to offer specific advice or recommendations to any individual. All performance references are historical and no guarantee of future results. All indices are unmanaged and not available for direct investment.”