Comparing LIRPs and Traditional Retirement Plans: What’s Best for Your Future?

Darcy Bergen

January 14, 2025

When planning for retirement, selecting the right savings vehicle is one of your most important decisions. Traditional retirement plans like 401(k)s and IRAs have long been popular choices, but life insurance retirement plans (LIRPs) are increasingly gaining attention for their unique benefits. To determine which option is best for your future, let’s explore the differences, advantages, and potential drawbacks of LIRPs and traditional retirement plans.

Understanding Traditional Retirement Plans

Traditional retirement plans, including 401(k)s, traditional IRAs, and Roth IRAs, are tax-advantaged savings accounts specifically designed for retirement. They allow individuals to invest in various financial assets, from stocks and bonds to mutual funds.

• 401(k)s: Employer-sponsored plans where contributions are often pre-tax, reducing your taxable income. Many employers offer matching contributions, which can significantly boost savings.
• Traditional IRAs: Individual retirement accounts with tax-deferred contributions, meaning you don’t pay taxes on contributions or earnings until withdrawal.
• Roth IRAs: These accounts use post-tax contributions, allowing for tax-free withdrawals of contributions and earnings in retirement.

What Are Life Insurance Retirement Plans (LIRPs)?

A LIRP is a permanent life insurance policy—such as whole life or indexed universal life insurance (IUL)—structured to serve dual purposes: providing a death benefit and accumulating cash value. The cash value grows tax-deferred and can be accessed tax-free via loans or withdrawals, making it a flexible retirement income source.

Tax Benefits: A Key Comparison

• Traditional Plans:
• Contributions to traditional 401(k)s and IRAs reduce taxable income, offering immediate tax savings. However, retirement withdrawal is taxed as ordinary income, which can be a disadvantage if you expect to be in a higher tax bracket later. Roth IRAs, on the other hand, provide tax-free withdrawals but offer no upfront tax deductions.
• LIRPs:
• Contributions to LIRPs are made with after-tax dollars, similar to a Roth IRA. The cash value grows tax-deferred, and policyholders can access funds tax-free through loans or withdrawals. Unlike traditional plans, LIRPs are not subject to required minimum distributions (RMDs).

Flexibility and Accessibility

• Traditional Plans:
• Strict rules govern traditional retirement plans. Withdrawals before age 59½ typically incur a 10% penalty, plus income taxes. There are also contribution limits: for 2024, 401(k) contributions are capped at $23,000 (or $30,500 for those aged 50 and older), and IRAs have a $7,000 limit ($8,000 for those over 50). Roth IRAs come with income limits that restrict eligibility for high earners.
• LIRPs:
• LIRPs offer greater flexibility. There are no contribution limits, making them appealing to high-income earners who want to save more than traditional plans allow. Additionally, you can access the cash value without penalties, provided the policy is structured correctly and remains in force.

Risk and Investment Growth

• Traditional Plans:
• The growth of investments in traditional plans depends on market performance. While this can lead to substantial returns over time, it also exposes your savings to market risk, especially during economic downturns.
• LIRPs:
• LIRPs often feature a guaranteed minimum interest rate, which protects the cash value from market losses. Indexed universal life (IUL) policies, for instance, link cash value growth to a stock market index like the S&P 500, offering the potential for higher returns without direct exposure to market downturns. However, these policies may have caps on earnings, limiting upside potential.

Estate Planning and Legacy

• Traditional Plans:
• TraditionalTraditional retirement plans pass to designated beneficiaries upon the account holder’s death upon the account holder’s death. However, inherited IRAs now require beneficiaries to withdraw the entire balance within 10 years, potentially resulting in significant tax implications.
• LIRPs:
• LIRPs include a death benefit, which is typically paid to beneficiaries tax-free. This makes them an attractive option for those who prioritize leaving a legacy. Additionally, the death benefit bypasses probate, ensuring a smooth transfer of wealth to heirs.

Costs and Fees

• Traditional Plans:
• Traditional plans usually involve minimal administrative costs, though mutual fund fees and investment management charges can add up over time. Most employers cover the cost of administering 401(k) plans.
• LIRPs:
• LIRPs often come with higher costs, particularly in the early years. These include premiums, administrative fees, and mortality charges. While these expenses can be significant, the tax advantages and death benefits may offset them over time.

Suitability: Who Should Choose What?

• Traditional Plans:
• These plans are ideal for individuals seeking straightforward, tax-advantaged retirement savings. Employer-sponsored 401(k) plans benefit employees who receive matching contributions. Traditional and Roth IRAs are great for those who qualify for their respective tax benefits.
• LIRPs:
• LIRPs are well-suited for high-income earners who have maxed out contributions to traditional retirement plans. They’re also a good option for individuals seeking additional tax diversification, estate planning benefits, and flexible access to funds. However, they require a long-term commitment and may not be ideal for those with short-term financial needs.

Combining LIRPs and Traditional Plans

In many cases, the best strategy is not choosing one over the other but using both. For instance:

• Tax Diversification: Having funds in both taxable and tax-free accounts provides flexibility in retirement and allows you to manage tax liability more effectively.
• Income Bridging: Use traditional plans for long-term growth and RMDs while leveraging LIRPs for tax-free withdrawals during market downturns or unexpected expenses.

Choosing between LIRPs and traditional retirement plans depends on your financial goals, income level, and risk tolerance. Traditional plans like 401(k)s and IRAs remain foundational tools for retirement savings, offering simplicity and immediate tax benefits. However, LIRPs provide unique advantages, including tax-free growth, flexibility, and a death benefit that can secure your legacy.

For most people, combining these strategies delivers the best of both worlds. By diversifying your retirement savings vehicles, you can optimize tax efficiency, minimize risk, and create a more resilient financial future. Consult an economic advisor to design a retirement strategy tailored to your unique needs and aspirations.