The Top 4 Pitfalls of a LIRP | What you need to know about LIRPs before you get into using them

 

Troy Sharpe: What are the top four pitfalls of a LIRP? LIRPS can be powerful, financial planning tools that we use for a portion of your assets if you  qualify regarding the benefits and features that we’ve covered in this series so far, but there are always downsides to every financial tool. You need to be aware of the four pitfalls of  the LIRP, and how to avoid them.

Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, CERTIFIED FINANCIAL PLANNER™ Professional (CFP®), and host to the Retirement Income Show. The first one that we see, and I’ve seen this over the years where people have  come in, they’ve bought some type of LIRP from some former advisor or someone they worked within the past, and they’re extremely upset at the advisor, they don’t understand why  the tool was recommended. What tends to be a common occurrence is that they never fully funded the retirement planning tool. They never fully  funded the LIRP.

What does this mean? Let’s say you have a really good job and you have excess income, one of the qualifications from the first video to consider a LIRP,  and you’re saving $50,000 per year. Now, you’ve already maxed out your 401k, you’ve contributed to your Roth, you’ve got your employer match, you have money in the bank, your liquidity,  those are the types of things you need to be in a position before you even consider something like this. Let’s say you’ve done that and you still have this money to save, and then you decide to  buy a LIRP.

You have to continue to fund that strategy. If it’s structured to be funded over a five-year or a seven-year or a ten-year, or  however it’s originally structured, this is why structure is so important, you have to fully fund it. You have to stay committed. If you lose your job, then that could put you into  a bad situation where you don’t fully fund it. Whenever we work with people, and this is a viable tool possibly for their situation, we like to see enough assets, either in the bank  or an investment account, to make sure, if they lose their job, if their income situation changes, they have enough assets to continue to fully fund it, because if you don’t continue to fully  fund it, if you don’t commit to the plan that was originally set out, the policy will ultimately implode, and every dollar you’ve put in will be lost.

You’ll lose the death benefit coverage,  you’ll lose all the benefits and features, and the money that you put in. One of the biggest pitfalls here is that someone commits to a five-year or seven-year, maybe a 10-year funding schedule or even  longer, and they don’t follow through, they don’t fully fund. When you do that, the policy will ultimately collapse. It may be five years or 25 years, but ultimately, it almost certainly  will collapse.

Several consecutive years of market downturns, number two. There are ways to mitigate this risk, but  if the market is down for five consecutive years, one of the risks with these policies because of the expenses that are involved, they are dependent on the  policy’s earning interest. The interest that is earned as you put more money in.

Let’s say you put 50,000 in at first and you earn 10%, well, that’s only  $5,000, that doesn’t cover the expenses, but if it’s fully funded and now you have $250,000 in and earn 10%, that covers the expenses plus  much more.

If we have several consecutive years of market downturns in the beginning of these policies once they’re structured, we’re not earning interest  to offset the expenses that are being charged, it could put you into a tight situation where it takes a long time for these to rebound. Now, there are strategies to mitigate this,  and I’ll talk about it on the next video in this series, but understanding that because of the expenses, we simply need to have consistent interest earned in these. That’s the key, we want consistent  interest.

Number three, pitfall, not monitoring, and adjusting. We have to ask for what’s called in-force illustrations. We don’t  technically need to have these every single year, but we need to be doing these at least every two to three years. This is actually two different things here. You have to monitor the policy. How much interest  did you earn? What are the expenses that are coming out? What is the cash value? Understand what’s going on with your policy. If we need to adjust, that means if we’re in the policy loan  phase where we’re taking tax-free income, maybe we need to take a little bit less out. If we have a good year, maybe we can take a little bit more, but we want to be conservative with these, so  we need to monitor it and we need to adjust as time goes on.

In-force illustrations. This is when we call the insurance company and we ask, give me an  illustration of the policy of the in-force policy. What they’re going to do is they’re going to send you back, typically either by email, or normal mail, how the policy  is operating. You can compare that to when you originally purchased it, but also we’re going to look at how long will this policy last, how much income can it provide on a fully guaranteed basis.  Also, with a projected average interest rate of say 5% or 6% or 7%. We want to be running these in-force illustrations, so we’re  aware of how the policy’s doing relative to our original assumptions.

The big one here, number four, is taking out too much money.  If you take out too much money and the cash value goes to zero, the policy implodes and all of those policy loans that you’ve taken in the past become subject to income  tax because it’s no longer a life insurance policy because the death benefit is gone. This is why we have to monitor and adjust, we have to run in-force illustrations, we have  to fully fund, all of these things is essentially to make sure the policy doesn’t implode, the policy’s cash value doesn’t go to zero, therefore there is no more policy.

One way that that can also happen is if you take out too much money, which will cause a taxable income event. These are the top four pitfalls of a LIRP. If you have one, if  you know someone that’s considering one, make sure to share this video with a friend or family member, hit that thumbs up button and subscribe to the channel, and if you haven’t seen the rest of the videos in this series, go back to the beginning,  watch them because it can be a very, very powerful tool, but it needs to be managed properly. We’ll see you on the next video.