Retirement Investor

Using Life Insurance for Tax-Free Savings in Addition to Protection


Life insurance is often thought of as a tool for providing money at the death of the insured and this overlooks its usefulness in accumulating cash to supplement retirement. A life insurance retirement plan (“LIRP”) is essentially an overfunded cash value life insurance policy, such as an indexed universal life, variable universal life or whole life policy, where the amount of money contributed is greater than the premiums needed to support the underlying cost of insurance charges deducted from the cash value to provide for the death benefit protection. The intent is to minimize the death benefit protection element, and resulting policy charges, and maximize the cash value accumulation potential for future withdrawals and policy loans which can be income tax-free if the policy is structured and managed correctly.

There are many potential benefits to using a LIRP as a supplemental retirement vehicle, including tax-deferred accumulation, income tax-free distributions, no age restrictions or tax penalties for access to cash value, availability of a variety of investment options for crediting interest to the cash value, and valuable death benefit protection for the insured’s beneficiaries should he or she die before prematurely before future income and retirement contributions are lost. LIRPs are not subject to stated annual contribution limits, withdrawal penalties and required minimum distributions like what exists with traditional retirement plan accounts. The maximum amount of premium that can be paid into a life insurance policy is governed by the calculations required by Internal Revenue Code (IRC) section 7702 and section 7702A. Under these calculations, which are done by the insurance company, the maximum premium is typically correlated to the initial face amount – the maximum available amount of which is generally correlated to the income and net worth of the insured. Those seeking to supplement their existing retirement plans find LIRPs provide the ability to save a potentially large amount of money, larger so for those with larger incomes and net worth, while receiving several attractive tax benefits.

How It Works

For a LIRP to be effective, a policy must be structured and funded as a non-Modified Endowment Contract (“non-MEC”) which requires as few as four annual premium payments. A non-MEC structure permits the policy’s cash values to be accessed via withdrawals up to cost basis and policy loans that can be income tax-free as long as the policy remains in-force until the insured’s death and the policy never becomes a MEC. Any distributions from a MEC policy, which can include withdrawals, loans or deemed distributions from pledging the MEC as security for a loan, are includable in the policy owner’s gross income and taxable to the extent of gain on a last-in-first-out (LIFO) basis. A 10% penalty also applies, to the extent of gain, for distributions occurring before the policy owner reaches age 59½.

Next, the owner of a LIRP should not expect to access the policy’s cash values for at least 10 years if not 15 or more. “LIRP participants should accept that the plan needs time to work,” says Nate Barnes, a Senior Vice President for Lion Street’s Private Client Group in Denver. Barnes focuses on assisting financial professionals with incorporating life insurance strategies into their comprehensive financial planning and has seen LIRPs grow in popularity. “Time is critical because in order to maintain a LIRP’s tax benefits, it must meet the Internal Revenue Code’s definition of life insurance, and this requires a significant amount of death benefit in a policy’s early years. Depending upon age, sex and health, the insurance costs drop to nearly negligible amounts after 10-15 years when much of the initial death benefit can be eliminated.” 

At this point, the cash value growth can be maximized and the tax benefits of a LIRP begin to take shape and offset the cost of the higher charges in the early years. If someone cannot commit to a lengthy time horizon to realize the advantages of a LIRP, they are likely better off to consider other financial alternatives.

Another caveat for making a LIRP effective is the age and health of the insured, which can make all the difference in having a LIRP perform exceptionally well versus doing just fine or perhaps not being worth it. Older ages mean higher insurance costs and a shorter time horizon, and either of these characteristics may impact the viability of a LIRP. From a health perspective, clients with health ratings assessed to their policies by insurance companies may see insurance costs that can dampen or overwhelm the policy’s performance potential.

When a LIRP owner needs supplemental income for retirement or for any other need, cash can be taken from the policy in a combination of income tax-free withdrawals up to cost basis and income tax-free policy loans, the principal and interest on which are generally repaid from the policy’s income tax-free death benefit when the insured dies. Unlike traditional retirement plans, there is not a minimum age requirement to access a LIRP or an age at which minimum distributions are required. However, the owner should understand that loans from a policy structured as a non-MEC only remain income tax-free if the policy stays in-force until the death of the insured. If the policy lapses or is surrendered, the excess of any outstanding policy loan plus any additional cash surrender value over the policy owner’s adjusted cost basis will be taxable at ordinary income rates.

Potential Pros of a LIRP

  • Income tax-free retirement income without age restrictions for access
  • Tax-deferred build-up of policy cash values
  • Contributions only limited by policy death benefit capacity
  • Death benefit capacity is generally higher for those with higher income or net worth
  • Access to a variety of investment options for crediting interest to the cash value
  • Death benefit proceeds generally received income tax free by beneficiaries

Potential Cons of a LIRP

  • Long-term commitment to realize benefits
  • Low initial surrender values in early years
  • Impaired performance if issued to an insured who is older and/or in poor health
  • Risk of policy lapse resulting in taxation to cash value growth if not funded or managed properly
  • Financial and medical underwriting apply to determine insurability
  • Policy charges deducted from the cash value which can be greater in the early years

Who Should Consider a LIRP?

LIRPs offer an effective way to save more for retirement but some of the restrictions mean that these plans are not for everyone. Optimally, LIRPs are a fit for those in relatively good health who have a need for death benefit protection, are maximizing contributions to traditional qualified retirement plans, such as a 401(k) plan, and longer-term time frame before needing access to distributions – mainly people in their mid-50s or younger. 

Another member of Lion Street’s Private Client Group, Celeste C. Moya, a Senior Vice President in Dallas, assists prospective LIRP purchasers. “Generally, the ideal candidate for a LIRP is someone who has maxed out their qualified plans, exceeds the income limitations to use a Roth IRA and has disposable income they can use to further grow and diversify their retirement portfolio.”

An exception to this description may be a business owner. “Some small business owners may not have access to traditional retirement plans so a LIRP may be their only retirement planning strategy,” says Moya.

When choosing a LIRP, a participant must be able to commit to meeting the initial funding schedule in order to best control policy costs and grow the cash value. This includes not only budgeting the necessary amount for premiums each year but designing the policy so that, from the start, the LIRP is designed to maximize cash value accumulation potential and minimize long-term death benefit protection. If planned premiums are not maintained, cash value performance may suffer, and the policy owner should commit to at least the first five premium payments of an optimally designed LIRP.

Policy Types

The most commonly used policy types for LIRPs are whole life, indexed universal life and variable universal life. Each has advantages and disadvantages and prospective LIRP participants should understand how each works and the relative risks and rewards involved. 

Whole Life Insurance (WL)

Whole life policies have guaranteed cash value accumulation and a guaranteed death benefit, assuming the required premiums are paid. The rate of cash value accumulation is guaranteed in the policy contract. A participating whole life policy is eligible to receive dividends each year from the insurance company, which are a participation in the surplus performance of the insurance company, which can be used to buy “paid-up additions” within the policy that enhance cash value accumulation and death benefit beyond the base guaranteed amounts. Because base values and past dividends credited are guaranteed, the policy owner does not assume any investment risk but the uncertainty of what future dividends and policy performance will be relative to what was originally illustrated.

Indexed Universal Life (IUL)

Indexed universal life is a type of universal life where the cost of insurance charges are deducted from, and interest is credited to, the cash value on a periodic basis. The policy owner is permitted to select from various investment options for crediting interest to the cash value that are linked to the performance of one or more stock market indices, such as the S&P 500, over specific periods of time (typically 12 month periods) and subject to upside limitations on the growth with a minimum guaranteed floor of 0%. This permits the policy owner the opportunity for greater cash value growth potential than with whole life without the risk of negative returns from stock market volatility. However, the charges deducted from the cash value monthly, and interest that is credited to the cash value, are not guaranteed. The lesser guarantees and greater variability of stock market returns and index-linked interest rates compared to the dividends and guaranteed accumulation of a whole life policy means the policy owner will assume more investment risk over time. 

“Indexed universal life is a good product for a LIRP design,” says Moya. “It is not very aggressive, offers a range of stable returns and has downside protection. Although there are typically caps on performance, the growth potential can be attractive and can help offset the lesser guarantees and predictability as compared to whole life.”

Variable Universal Life (VUL)

Variable universal life works off the same policy chassis as indexed universal life except the cash value is invested into equity investment options offered by the carrier and chosen by the policy owner that resemble traditional mutual funds. Because of direct equity investment, there are no restrictions to how much the cash value can grow or fall, providing for maximum long-term growth potential but also maximum exposure to volatility and investment risk.

Nate Barnes is seeing tremendous growth in the use of variable universal life as the product choice for LIRPs. “In thinking about the last year, 60% to 70% of the LIRP designs I have come across have incorporated a VUL. Many of the new VUL policies in the market have indexed sub accounts which integrates some of the features of an indexed universal life contract, including some downside protection.”

Moya agrees. “Someone who is younger and has time to be somewhat aggressive in their retirement planning might find a VUL a fit especially considering the maximum amount of investment flexibility the policy offers as compared to others. My advice to anyone choosing a VUL as a LIRP funding vehicle is to use a financial advisor to help monitor the policy to make sure it remains on track to meet their retirement income goals.”

The most important consideration in selecting one policy type vs. another, or some combination of policy types, is that the selection lines up with the policy owner’s risk tolerance.

Time to Consider a LIRP?

 As saving in traditional retirement plans becomes more complex and limiting, a LIRP may be a solution to saving more for retirement for high-income-earning and high-net-worth individuals. Simple to establish, sometimes with limited medical underwriting due to advancements in digital underwriting platforms, LIRPs are increasingly being established to meet current protection and future wealth accumulation shortfalls. An experienced life insurance professional should be consulted to help determine suitability, assist in design and to choose the best policy and carrier for implementation.


Policy loans reduce death benefits and are subject to interest rates as detailed in the contract. 

Indexed Universal Life Insurance is an insurance contract that, depending on the contract, may offer a guaranteed annual interest rate and some participation growth, if any, of a stock market index. Such contracts have substantial variation in terms, costs of guarantees and features and may cap participation or returns in significant ways. Any guarantees offered are backed by the financial strength of the insurance company, not an outside entity. Investors are cautioned to carefully review an indexed universal life insurance for its features, costs, risks, and how the variables are calculated.


Please consider the investment objectives, risks, charges, expenses, and your need for death-benefit coverage carefully before investing. The prospectus, which contains this and other information about the variable life policy and the underlying investment options, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

The investment return and principal value of the variable life policy are not guaranteed. Variable life sub-accounts fluctuate with changes in market conditions. The principal may be worth more or less than the original amount invested when the policy is surrendered. Any guarantees offered are backed by the financial strength of the insurance company.

Tom Brooks, CLU®, ChFC®, CPCU®, RHU®


Tom Brooks is a registered representative of Lion Street Financial, LLC, member FINRA and SIPC.

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