The 'Life Insurance Retirement Plan' is Back. But is it Right For You.
If you work in a high-earning occupation like technology or healthcare, you have probably found yourself sitting through your fair share of sales pitches for life insurance, wondering how you got there. And when those sales pitches are concealed behind buzz phrases such as “family banking” or “7702 plans,” you are right to be skeptical and keep your hand on your wallet.
In most cases, you are better off buying inexpensive term coverage to protect against any income gaps for financial dependents and then investing the difference that would’ve gone toward a lifetime of monthly premiums into a low-cost index fund instead. However, for the right person with a long enough time horizon, a life insurance retirement plan (LIRP) can make sense.
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At its core, an LIRP is just a marketing label put on a permanent life insurance policy—whole life, universal life, indexed UL (IUL), or variable UL (VUL)—intended to be overfunded and to accumulate cash value in a short period of time. Then, in retirement, the policy owner taps that value via basis withdrawals and policy loans without incurring any income tax in the process.
Understand that when funding an LIRP, you can’t simply write one big check and call it a day. The tax code doesn’t allow it. Instead, insurers calculate the amount of premium that can be paid into the policy during its first seven years without causing the contract to be reclassified as a Modified Endowment Contract (MEC), which changes the order distributions are taxed and can trigger penalties.
Once a policy becomes an MEC, there’s no reversing it, so the way you schedule contributions in those early years matters a great deal. That’s why in most cases, premium payments are spread over roughly seven years, often in equal installments, with the sole goal of contributing as much cash as possible without tripping the MEC rules.
By front-loading premiums during that window, you give the policy’s cash value time to compound while keeping its favorable tax treatment intact. After that initial funding period, premiums can either be reduced or stopped altogether if the policy is sufficiently capitalized.
Accessing the money typically follows a two-phased approach. First, the policy owner performs partial surrenders up to their basis (total premiums paid), which come out tax-free under the tax code’s FIFO rules for life insurance. Next, the policy owner switches to taking policy loans against the remaining cash value.
As long as policy loans are properly managed, they are not considered income. As such, they don’t show up in your adjusted gross income in retirement. The outstanding balance is simply subtracted from your policy’s death benefit whenever you pass away.
An LIRP is not for everyone, but for a narrow slice of high earners it can provide meaningful benefits. If you’ve already maxed out the obvious retirement savings vehicles—your 401(k) or other workplace retirement account, a supplemental executive retirement plan or any other long-term incentive plan—yet you still find yourself with excess monthly cash flow, the question becomes what to do with those dollars next.
Parking any excess cash in a money market savings account may feel safe, but at today’s rates, the opportunity cost of letting large sums sit idle for decades is significant. A properly designed LIRP can provide you with another tax-advantaged bucket with the potential to grow uninterrupted for a decade or more.
Strategies like the LIRP are already popular among corporate executives and other high-ranking professionals who have exhausted their traditional retirement savings vehicles. Consider the instance of a 50-year-old executive working for Apple who has been diligent about saving. Each year, they fully fund their workplace retirement plans and executive benefits—filling all available pre-tax and after-tax buckets. After that, they still end up with an excess of $10,000 a month in discretionary cash flow, which piles up in a savings account.
By redirecting half of that monthly surplus into a carefully structured LIRP for the next seven years (depending on market returns), the executive in this example could accumulate upwards of an additional $1.5 million in cash value by the time they reach age 65 and seek to retire—adding a degree of tax diversification that most retirees find increasingly valuable once their paychecks stop.
In the end, the decision to incorporate an LIRP into your broader financial plan comes down to fit and appropriateness. For most people, the simplicity of term insurance paired with systematic investing remain the most efficient path. But if you’re a high earner with a long enough time horizon and surplus cash flow, an LIRP can serve as more than just another life insurance policy. It can become a flexible planning tool—offering additional liquidity when needed and ultimately leaving your heirs a meaningful financial legacy if you don’t.
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Malcolm Ethridge is the Managing Partner at Capital Area Planning Group, based in Washington, D.C. His areas of expertise include retirement planning, investment portfolio development, tax planning, insurance, equity compensation and other executive benefits.
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Disclosures:
The information provided is for educational and informational purposes only, does not constitute investment advice, and should not be relied upon as such. Be sure to consult with your legal advisors before taking any action that could have tax and legal consequences.
Investments in securities and insurance products are:
NOT FDIC-INSURED | NOT BANK-GUARANTEED | MAY LOSE VALUE