LIRP Case Study: How a LIRP Helped Solve One Person’s Retirement Plan Goals
Troy Sharpe: Fees are what you pay, and value is what you receive. When it comes to a LIRP, are the fees worth the benefits offered? Well, that’s for you to decide, but this video will help you understand what those fees are, and what the value proposition is behind that cost.
Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, CERTIFIED FINANCIAL PLANNER™ Professional (CFP®), and host of The Retirement Income Show. About eight or nine years ago, I had a client come to me, and he said, “Troy, I want to invest in one of these LIRPs.” Well, at the time, I wasn’t a big fan of these because of the expenses upfront that come out of the cash value in support of the life insurance.
He said, “Troy, I’ve been doing the research. I want to do this. I’m either going to do it with you or without you.” After a little bit more conversing about the pros and cons of this, he said, “Troy, look, I really want you to help guide me through this as time goes on because it’s a long-term strategy, and I’m going to do it one way or the other.” I agreed to help him.
We’re going to go through a case study, today, of what has transpired over the past eight or nine years, while also teaching you some of the things you need to be aware of if you’re going to determine if this LIRP strategy is appropriate for you in your particular situation. Of course, you always want to talk to fiduciary, who’s going to help you understand how these work, the things that you maybe don’t understand from a language standpoint because it can be a different language, life insurance, but also how things fit into your overall financial picture.
A fiduciary, a financial investment advisor, is one of the best people to help you figure this out, but they also have to be licensed in the insurance industry to help you execute and monitor the strategy moving forward. Client was a 52-year-old male. He had an extra $100,000 to invest. He was very healthy. He did want to secure a death benefit but he also wanted long-term care protection. We uncovered this in the initial fact-finding discovery phase, this was something very important to him. He wanted his funds protected from lawsuits.
He had a liability policy, but for many people who have accumulated a significant amount of wealth, $1 million liability policy, or often a two or $3 million liability policy isn’t enough. If something were to happen and you get sued, you could be sued for far more than that. Whatever he invested in, he did value the fact that this investment would protect him from lawsuits and provide creditor protection.
He wanted no market risk. This was the real big one for me, that made it very clear that whatever he did with this money, he did not want it in stocks, he did not want it in bonds, he did not want to see the value fluctuate because the market went down. These were his objectives, what he wanted to see accomplished, at the same time who he was. He was very healthy. He was a 52-year-old-male. He wanted no market risk. He wasn’t an aggressive investor.
It’s extremely important when we structure these policies that they get structured properly. A long time ago, before the government really regulated the structure of these policies, investors would throw millions and millions of dollars into them because of the tax-free nature of life insurance. They would grow tax-free, they could take it all out tax-free, the death benefit was tax-free. They were essentially a tool to escape taxes.
The IRS came in and said, “Okay, if you’re going to use life insurance, it needs to be structured as life insurance.” They created what’s called Section 7702 of the Internal Revenue Code. This section of the code is what determines if life insurance is actually life insurance or if it’s an investment. If it’s an investment, then it gets taxed as ordinary income. You have to structure it, where money is paid in over a series of years, otherwise it’s determined to be what’s called a modified endowment contract.
When you make a payment over a certain number of years, you must have a death benefit that is at a certain level. The key to structuring these is to get the most amount of money inside the policy as quickly as possible, without violating Section 7702 of the Internal Revenue Code, while also having a minimum death benefit. You want this designed as a maximum cash value accumulation play, with a minimum death benefit allowed by the IRS.
Now, we are buying life insurance. There are expenses. This is why I was not a big fan of the LIRP initially, until I actually seen it play out over the course of several years. To give you an idea here, the first $100,000 that he put in, he had a death benefit starting out day one of about $1.8 million. Tax-free death benefit, if he gets hit by a bus, if he passes away for any reason. He put a $100,000 in, his family was going to get $1.8 million tax-free. Now, this $1.8 million, a significant portion of it was also available to him if he should become disabled or need long-term care protection. That was an attractive feature to him as well.
Now, because of the expenses, we are buying life insurance, his cash value, year one, was about $80,000. The difference between what he put in and the cash value, those are the expenses that came out of the policy. This is why I wasn’t a big fan of this. I’m a big fan of the stock market. “Let’s put this money in the market. It can grow long-term to become a lot more.”
Looking at these two compared to one another, the stock market investment, it would be taxed every single year, you could lose a significant amount of money. You also pay fees in the stock market account. There are pros and cons to everything. Nothing is inherently good or bad, it’s just you need to be aware as the consumer, “What are the good parts? What are the bad parts?” and then make a determination yourself of, does it make sense for you?
Now, couple key things here to really understand. Year one, when he puts $100,000 in and the death benefit is $1.8, technically, he’s put $100,000 in, so there’s only $1.7 million of death benefit. The difference between the premium paid and your death benefit is what we call the corridor. Only about $1.7 million of life insurance if he were to die, because he invested $100,000.
Now, he’s going to earn interest on this $100,000. This is what we call an indexed universal life policy, which means as the market goes up, the interest earned from participating in the market without the market risk gets credited to the policy. Typically, you’re going to make anywhere from zero to about 14% or 15% on most of these policies, somewhere in that range.
We’re going to assume this policy, for simple computational purposes, earns 10% per year. That’s higher than the averages that you should expect to earn in a policy like this, but I want the math to be simple, so you understand and I’m able to do it with you as we go through this example. If he earns 10% on $100,000, that’s $10,000 of interest. Not enough to pay for the expense.
The two things I said I wanted you to remember there is, he puts $100,000 in, $1.8 death benefit, there’s technically only $1.7 million. The actual amount of insurance you have is the net between the actual death benefit and the deposit. The fact that we’re earning interest on the amount that’s been deposited here is not enough to cover the expenses.
Year two comes around, he makes a second $100,000 investment. Now we have $200,000 in there. Now, if we earn 10%, we’re earning 10% on $200,000 or $20,000 of interest. Also, the death benefit is still $1.8 million, but the net death benefit is now $1.6. That corridor has shrunk the actual amount of insurance it has. Why is this important? Because that amount of net insurance is one of the big contributing factors to the expenses inside the policy.
As time goes on, as we get more and more money invested, we’re earning more and more interest on these dollars. After five years and we have $500,000 invested, if we earn 10%, we’re earning $50,000 in interest. Additionally, the net between the death benefit and the cumulative premium deposited is now about $1.3 million. The corridor has shrunk further. You have less insurance, therefore less cost of insurance, the expenses are reduced because of that.
Those two factors, the increasing cash value, which leads to the potential to earn more interest because you can earn more interest on $500,000 than $100,000, and the fact that the corridor is shrinking as more and more money gets deposited, is why I say these things are like buying a home. You have to build equity in them over time.
The goal after, if it’s structured on a five-year period, with expenses and earning interest, I typically like to set the client expectation. What we try to monitor is, we want to see a cash value, that’s what CV is, a cash value, equal to about what we’ve invested over the years. That’s a decent goal to have. It might be a little bit less, it might be a little bit more, but it’s like we’re building equity in the LIRP.
Now, after the five-year investment period, this client had about $500,000. He did reach his cash value. He had a little bit more in his cash value than what he had deposited after a five-year period. If we compare that to the stock market, he could have invested 500 in the stock market, and at the end of five years, he could have had 600, 700, 800, He could have had a lot more money. He also could have had a lot less. There’s a certain amount of uncertainty there with what the stock market is going to do.
He did not want that. Because the index universal life policy is protected 100% from market losses, all we have to overcome are the expenses of the policy. Side note here, this is why I do not like variable universal life insurance policies. Variable policies means you actually invest in mutual funds. You do not want to be in a opposition to where you have to overcome market losses and insurance company expenses. That’s a double-edged sword that can cause the cash value to go to zero and if the value goes to zero, the policy implodes and you lose everything.
That’s the big reason why I’m not a fan of variable policies. The fixed policies, the ones that protect your principal 100% from market losses could possibly be a viable solution as a tool of an overall retirement plan for you. Now, at the end of the five-year period, he had about $500,000 there. This now is one giant lump sum of money. That’s 100% protected from lawsuits, 100% protected from market losses. The insurance costs are very, very small compared to when they started out. He’s going to earn somewhere between zero and 15% on this money and whenever he goes to take it out, it’s all going to be tax-free.
It’s all going to be tax-free. He’ll never pay a single dollar in taxes on withdrawals from this policy through policy loans, if managed correctly. We look as time goes on here. Now he’s up to about $750,000. It’s been a few years after it’s been fully funded and it’s just been sitting there earning interest, earning interest, earning interest in a safe, protected environment, growing tax-free.
If he wants to start taking money out, he can start taking money out to supplement his retirement income. He doesn’t need to right now, this was a long-term investment for him. When he needs to start taking income out, let’s say he wants to start taking $50,000 per year. That’s going to be a tax-free retirement income for him. As you can see, there are many different benefits here from the creditor protection, the lawsuit protection, the principal being safe from market losses. The fact that the money can be taken out tax-free, that he has the death benefit that will go to the family tax-free, long-term care protection as well.
The question then becomes what that value that’s being provided from the LIRP and the fees that are associated with it and the fact that this is a long-term investment that’s for you to decide if something like this could make sense for your retirement. If you’re understanding of the fees that are associated with it, and the value that you get in return, you don’t want to commit all of your retirement dollars to this.
That’s never prudent to do that with any type of investment. For a portion, it doesn’t have to be a $100,000 a year for you to get benefit from this. For many of you, it might be $5,000 a year, and it might best be structured over 20 years. It might be $25,000 over seven years. It might be $10,000 over 10 years. It might be even a lesser or higher number but the important part is that you structure it based on what makes the most sense for your complete financial picture and also your life insurance needs.
A lot of information here in this video, we’re going to continue with this series to talk more about the different choices of how to take income out. There are participating loans. There are what we call wash loans. You can do what we call withdrawals from basis. Several options when it comes to taking withdrawals from these policies, not all insurance companies are exactly the same. Therefore, not all policies are exactly the same, but you need to understand these basic facts if you’re looking to add something like this to your plan.
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