Life Insurance Retirement Plans: Meaning and Function

Enter your ZIP code to get started


Free. Simple. Secure.

Banner image
ByMelissa Wylie
Edited byCasie McCoskey
ByMelissa Wylie
Edited byCasie McCoskey

Updated: May 22, 2024

Advertising & Editorial Disclosure

Life insurance primarily provides financial security for beneficiaries, but it can also be a powerful tool in retirement planning. This strategy, called a life insurance retirement plan (LIRP), uses the cash value component of a permanent life insurance policy to supplement retirement income. The cash value, which grows over time, can be accessed during retirement, providing an additional source of income.

LIRPs offer significant benefits like tax advantages, as the cash value grows tax-deferred, and flexibility, allowing funds to be withdrawn without penalties. These features make investing in life insurance for retirement particularly appealing for certain people.

Life Insurance Retirement Plan Overview

A life insurance retirement plan (LIRP) is a strategy that uses the cash value of a permanent life insurance policy to provide supplemental income during retirement. This approach is not a standalone retirement plan but rather a supplement to traditional retirement savings vehicles like 401(k) plans and individual retirement accounts (IRAs). This strategy integrates the benefits of life insurance for retirement savings with traditional retirement planning approaches, enhancing overall financial stability in later years.

How a Life Insurance Retirement Plan Works

A LIRP operates around a permanent life insurance policy's cash value component. You can access this cash value upon retirement, providing an additional income source.

Although you can withdraw the cash value, doing so reduces the death benefit, impacting the amount your beneficiaries receive upon your death. Strategic planning is essential when using a LIRP to balance retirement income needs and the financial security of your beneficiaries.

Cash Value Component of a Life Insurance Policy

Cash value is a key feature of permanent life insurance policies. When you pay premiums on these policies, a certain percentage goes to a cash value account. This account functions much like an investment account within the policy. The insurance company invests it and grows over time on a tax-deferred basis, meaning you won't pay taxes on the growth until you withdraw the funds.

The exact percentage of your premium that goes into the cash value account depends on the terms of your individual policy and can vary based on factors like the type of policy, the insurance company and the policyholder's age and health.

Over time, the cash value account can grow substantially due to the portion of premiums allocated to the account and the interest or investment returns earned. The cash value can be accessed during the policyholder's lifetime, providing a potential source of funds for retirement income, emergencies or other financial needs. Its versatility underscores the potential benefits of investing in life insurance for retirement.

Types of Policies to Use for LIRP Accounts

Generally, any type of permanent life insurance policy with a cash value component is suitable for a LIRP. These include:

  • Whole Life Insurance: This policy type offers a guaranteed death benefit, ensuring a fixed sum for beneficiaries upon the policyholder's death. The premiums remain level, meaning they don't increase with age or health changes. The cash value component is an investment-like account that grows over time, enhancing your options for retirement planning with whole life insurance.

  • Universal Life Insurance: This policy type provides flexible premiums, allowing policyholders to adjust their payments as needed. It includes a death benefit and a cash value component. Cash value growth is based on a fixed interest rate or the performance of a specific market index, which offers the potential for market-linked growth. This flexibility may be worth considering when considering life insurance for retirement savings.

  • Variable Life Insurance: This policy type features a cash value component that can be invested in various subaccounts, similar to mutual funds. This allows policyholders to potentially increase their cash value through investment performance. However, it also means the policy's cash value and death benefit may fluctuate based on the performance of these investments, introducing more risk.

Consider what type of life insurance policy best suits your retirement needs and risk tolerance.

Who Should Use a Life Insurance Retirement Plan

A LIRP can be a strategic retirement planning tool for specific groups of policyholders, including the following:

  • High-Net-Worth Policyholders: LIRPs can be particularly advantageous for high-net-worth policyholders. These individuals often max out contributions to traditional retirement accounts like 401(k) plans and IRAs and are in search of additional avenues for tax-deferred savings. LIRPs provide this opportunity, allowing these policyholders to grow their wealth further in a tax-efficient way and enhance their financial security in retirement.

  • People With Lifelong Dependents: LIRPs can be a suitable choice for individuals with lifelong dependents, such as children with disabilities. These individuals have a unique need for continued life insurance coverage even into their retirement years. A LIRP provides this continued coverage and offers the potential for cash value accumulation that can be used as a supplemental income source in retirement.

A LIRP is more than just an insurance policy; it can be a versatile financial planning tool that can significantly influence one's retirement landscape. By choosing the right type of life insurance for retirement savings, individuals can secure a more resilient and flexible financial future, making it a wise choice for those qualifying under the described scenarios.

Who May Not Need a Life Insurance Retirement Plan

While a LIRP can be a beneficial strategy for some, it may not be the best choice for everyone. Those with limited income may find the premiums of permanent life insurance policies a bit high and may find it more worthwhile to maximize contributions to traditional retirement accounts.

Meanwhile, people close to retirement with insufficient life insurance coverage may not have enough time to build significant cash value in their policies. In such cases, a LIRP may not provide the expected retirement income.

Additionally, those with no dependents or whose dependents are financially independent may consider investing directly in a diversified portfolio if they're looking for better returns and more flexibility.

Advantages of Using Life Insurance for Retirement Plans

Using life insurance as a retirement plan can offer several benefits, which we highlight below:

  • Potential for Cash Value Growth: A life insurance policy's cash value component can grow over time, providing an additional source of income during retirement. This growth can supplement other retirement income sources, helping to ensure a comfortable retirement.

  • Tax Advantages: One significant benefit of using life insurance as a retirement plan is the tax advantage. The cash value within a life insurance policy grows tax-deferred, meaning you won't pay taxes on any earnings as long as the money remains within the policy. This can lead to substantial tax savings over time.

  • No Contribution Limits: Unlike traditional retirement accounts like 401(k) plans and IRAs, life insurance policies do not have annual contribution limits. This lack of restriction allows for greater flexibility in retirement planning and the potential for higher savings.

  • No Penalties for Early Withdrawal: Life insurance policies do not penalize for early withdrawal from the cash value, unlike 401(k) plans and IRAs, which typically impose penalties for withdrawals before age 59 1/2. This feature provides additional flexibility, especially in case of financial emergencies.

  • Guaranteed Death Benefit: Regardless of how the cash value performs, a permanent life insurance policy provides a guaranteed death benefit to your beneficiaries. This ensures that your loved ones will receive financial support after your death.

Ultimately, a LIRP can offer financial flexibility and security, making it an attractive component of a comprehensive retirement strategy.

Considerations When Using Life Insurance as a Retirement Plan

While life insurance retirement plans (LIRP) offer many advantages, there are also important considerations to keep in mind:

  • Cost: Permanent life insurance policies, which are necessary for LIRPs, typically have higher premiums than term life insurance policies due to the lifelong coverage and cash value component they offer. When considering life insurance for retirement savings, consider whether the potential benefits of a LIRP justify these higher costs.

  • Investment Risk: The insurance company often invests the cash value component of a life insurance policy, and the returns may not be as high as those of other investment options. This is especially true for policies where the cash value is invested conservatively. Consider the potential returns and your risk tolerance when deciding to use life insurance as a retirement plan.

  • Lower Death Benefit: You can access your policy's cash value during your lifetime, but your death benefit will decrease if you withdraw from it and pass away before paying it back. This means your beneficiaries will receive less money. Consider the potential impact on your beneficiaries when deciding to use your policy's cash value.

Before deciding to use life insurance as a retirement plan, consider all your options and weigh the potential downsides based on your circumstances.

How to Use Life Insurance as a Retirement Plan

Using life insurance as a retirement plan involves strategic planning and understanding the policy's features. Here are the steps to effectively use life insurance as a retirement plan:

Choose the Right Policy

The first step is to choose a permanent life insurance policy that suits your financial goals and risk tolerance. This could be a whole, universal or variable life insurance policy. Each of these policies has a cash value component that can be used for retirement income, but they differ in terms of premium flexibility, cash value growth and investment options.

Fund Your Policy

Once you have chosen the right policy, you need to fund it. This involves paying premiums that are split between the cost of insurance and the cash value component, which is integral to building a life insurance savings plan for retirement.

Overfund Your Policy (Optional)

If you have the financial capacity, consider overfunding your policy. This means paying more than the required premium to build up your cash value faster. However, be aware of the Modified Endowment Contract (MEC) limits, as exceeding these can result in less favorable tax treatment.

A life insurance policy becomes an MEC when it loses its tax benefits because it holds too much cash. The Internal Revenue Service (IRS) determines whether a policy is an MEC based on the total amount of premiums paid into the policy within the first seven years, a measure known as the "seven-pay test." If the premiums paid within those seven years exceed the amount needed to pay the policy in full, the policy is classified as an MEC.

Manage Your Cash Value

The cash value component of your policy is an investment-like account that grows over time. You should monitor this account and consider how it fits into your overall investment strategy. Some policies offer flexibility in how your cash value is invested, allowing you to tailor it to your risk tolerance and investment goals, which is key in investing in life insurance for retirement.

Plan Your Withdrawals

As you approach retirement, you should plan how to withdraw from your cash value. This could involve taking out loans against your cash value, making withdrawals or surrendering the policy. Each option has different tax implications and can impact the death benefit, so it's wise to plan this carefully to maximize life insurance for retirement savings.

Consult a Financial Advisor

Using life insurance as a retirement plan can be complex, and it's important to get it right. It may help to consult with a financial advisor who can provide personalized advice based on your individual circumstances. They can guide you in choosing the right policy, planning your funding and withdrawals and integrating this strategy into your overall retirement plan.

FAQ About Life Insurance Retirement Plans

The following commonly asked questions can help you better understand how to use life insurance as part of your retirement plan.

Can life insurance be used for retirement?
How does a LIRP work?
Can you cancel your life insurance retirement plan?
Do all companies offer life insurance retirement plans?
Is a LIRP a good investment?
How does whole life insurance work for retirement?

About Melissa Wylie

Melissa Wylie headshot

Melissa Wylie is a Content and SEO Manager at MoneyGeek. Melissa has worked in the financial content space since 2018 and has spent much of that time focused on all things small business.

Prior to joining MoneyGeek, Melissa held SEO positions at Bankrate and LendingTree. Melissa’s work has also appeared on LendingTree-owned websites ValuePenguin and MagnifyMoney.

Melissa began her career at American City Business Journals in 2015 as a reporter for the company’s women-focused publication Bizwomen. Melissa has a Bachelor of Arts in Journalism from the University of North Texas. Melissa relies on her foundation in journalism to craft content that simplifies complex financial topics to help everyone feel confident when making decisions with their money.

Melissa's other work can be read on LendingTree and Bizwomen.