Life Insurance Retirement Plans: Alternative or Rip-Off?

One risk inherent in the LIRP concept is the possibility that the policy will be incorrectly overfunded, resulting in the policy being classified as a MEC. Once a MEC, always a MEC; there is no fixing the mistake. If that happens, policy loans will be taxable on an income-first basis, eliminating most of the LIRP's benefits.

Another serious risk of using an overfunded life insurance policy as a retirement savings vehicle is the possibility that the policy will lapse with outstanding loans. As with all permanent insurance that allows policy loans, if the policy lapses or is otherwise canceled while loans are outstanding, the amount of the loan will be taxed to the insured.

Be aware that LIRPs and their ilk have been called a "scam" by many in the financial advice industry. The first complaint often levied against LIRPs is the relatively high fees associated with VUL policies. If the insured does not have a need for life insurance, the cost of insurance may be an unnecessary expense that eats a significant portion of premiums. On top of the cost of insurance, other fees can quickly eat the program's tax benefit. But a properly structured LIRP can dilute the effect of fees by aggressively overfunding the policy. The more money that is fed into the policy, the lower fees will be as a percentage of deposits. Policies that charge per deposit fees of 6 percent are obviously not good candidates for a LIRP.

Also problematic for some pre-retirees is the fact that their investment will be tied up for a period of time, unavailable for emergency purposes. Since a VUL policy is the backbone of the LIRP, it will have surrender charges for at least the first 10 years after the policy is issued.

Conclusion

The drawbacks of a using a LIRP as a supplemental retirement savings vehicle are less pronounced for high-net-worth families that have already maximized other tax-advantaged retirement accounts. The question for those clients is whether the fees associated with a VUL policy erase the program's benefits. The key is that they are normally only a supplement to an otherwise robust retirement plan.

Jordan Smith is the vice president of advanced design at Schechter Wealth in Birmingham, Michigan. He works with Schechter clients in the design and implementation of advanced strategies. Mr. Smith is an attorney that provides an important legal perspective to strategies that involve estate planning, taxation issues, trust design and the preservation and transfer of wealth.

Schechter Wealth is a boutique third generation wealth advisory firm. For over 75 years, their multi-disciplined team consisting of one or more JDs, CPAs, LLMs, CLUs, PFSs, CAPs, MBAs and CFA® charterholders has been quietly advising wealthy families on financial matters including: institutional quality investment advisory services, advanced life insurance planning, income and estate taxes, business succession, and charitable planning.