Advisor Perspectives
What is an LIRP and Why Should Clients Use Them?
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One of the most important ways a financial planner helps clients is by minimizing the taxation on their income. Tax-deferred qualified plans receive much of the focus during the accumulation years, but what about reducing taxes in retirement?
Chances are, your clients are in a lower marginal tax bracket now than they will be in the future. Two factors suggest that tax rates are likely to increase over time: current tax rates are set to expire in 2026 and, absent congressional action, return to pre-2018 levels; and future financial obligations of the U.S. government to entitlement programs may necessitate higher rates. To account for this probability, the key is to find additional future tax-free income for your clients.
You may be thinking, “I know where this is headed…annuities.” Over the last 10 years, I’ve had countless discussions with advisors about tax-deferred annuities. I occasionally hear comments like “My client already has too many tax-deferred assets,” or “Ordinary income tax rates will be higher when my clients take withdrawals than they are now.” These statements can be true, but the questions to ask are, “Does my client have enough tax-free income? How do I secure it?”
Using life insurance, not annuities, for tax free income
A life insurance retirement plan (LIRP) can be ideal for clients who have too much income to contribute to a Roth IRA (> $189,000, married). Because LIRPs have no contribution limits, if they are bought with a large enough death benefit (minimum non-MEC), they are very effective for generating tax-free income. Fees will be dependent on client age and underwriting, but with no premium load on commission-free products, more of the client assets go to work within the policy.
The strategy is to purchase as little a death benefit as possible to keep the client’s cost of insurance low (while still clearing the non-MEC death benefit threshold.) A non-commissioned life insurance policy is an ideal vehicle for this due to the cash accumulation potential.
The power of commission-free products
Permanent life insurance policies accumulate tax-deferred and allow for withdrawals and loans to be taken as tax-free distributions. Tax-free income does not count as provisional income and reduces the chance that Social Security income becomes taxable.
Utilizing tax-free income is key to minimizing taxes from other sources of retirement income. Funding retirement income solely from taxable sources like investments (that generate long- or short-term capital gains), tax deferred accounts (RMDs and annuity gains at ordinary income) and Social Security (highest marginal tax rate if provisional income limits are exceeded) can lessen the after-tax returns clients receive.
Even income generated from muni-bonds can be tricky – although advertised as tax-free, they can be taxed if you are a non-resident of that municipality, or if it’s a mutual fund built with taxable holdings.
Customizing a strategy to shift assets amongst these investment buckets during the accumulation years will pay off in later years. The goal is for your client’s provisional income not to exceed (or minimally exceed) the standard tax deduction at the time they start taking distributions. Often, at the time of retirement, itemized deductions are minimal.
New options for fiduciaries
Examining ways life insurance policies can be used as an investment – not just as insurance – may significantly reduce taxes for clients and allow them to enjoy more of their hard-earned savings during retirement.
Now…for clients who feel a moral obligation to pay more taxes, I’ll leave you with this famous quote by Judge Learned Hand:
Over and over again courts have said that there is nothing sinister in so arranging one's affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant.
Commissioner v. Newman, 159 F.2d 848, 851 (2d Cir. 1947)
As a consultant with DPL Financial Partners, Nicole Benz works with RIAs to help them leverage a range of commission-free insurance solutions for their clients.