Pros and Cons of Insured Retirement Plan (IRP)

Introduction

An Insured Retirement Plan (IRP) is a financial strategy that combines life insurance with retirement planning. It utilizes a permanent life insurance policy, such as whole life or universal life, to build wealth for retirement. By taking advantage of tax-deferred growth and the ability to access funds via loans, an IRP can offer significant benefits. However, like any investment strategy, it comes with both advantages and disadvantages. Understanding these pros and cons will help you decide if an IRP aligns with your financial goals.

What is an Insured Retirement Plan?

An Insured Retirement Plan is a strategy in which a permanent life insurance policy is used not only for life coverage but also as a tool for retirement savings. The policy accumulates wealth on a tax-deferred basis, allowing policyholders to access this accumulated value through loans in retirement, offering a tax-free income. Unlike other retirement vehicles, an IRP leverages the tax benefits of life insurance, allowing for compounded growth over time.

How Does an Insured Retirement Plan (IRP) Work?

An IRP typically follows a three-phase structure:

1. Accumulation/Saving Phase: You purchase a permanent life insurance policy with an investment component. Over your working years, you pay premiums to maximize the investments. During this time, the funds inside the policy grow on a tax-deferred basis.
2. Withdrawal Phase: Upon retirement, the policy's cash value has accumulated significantly. Instead of withdrawing the funds, you take an annual loan against the policy, which provides you with tax-free retirement income. The loan’s interest is typically rolled back into the policy.
3. Repayment Phase: Upon your death, the life insurance death benefit is used to pay off the outstanding loan. Since life insurance death benefits are typically tax-free, this ensures the loan is repaid without tax implications.

Pros of an Insured Retirement Plan

1. Tax Sheltering: The investments within the life insurance policy grow on a tax-deferred basis. Additionally, the loan used to access retirement income is tax-free, which can lead to significant savings.
2. No Impact on Retirement Benefits: The income derived from the loan doesn’t count as taxable income, which means it doesn’t affect income-tested retirement benefits like Old Age Security (OAS).
3. Life Insurance Protection: Even if you pass away before reaching retirement, your beneficiaries will receive the death benefit, which includes the accumulated investments. This ensures your loved ones are financially protected.
4. Wealth Building: By funding the policy with your target savings amount on top of the base policy premiums, you build wealth in a tax-advantaged manner
5. Flexibility: The IRP allows for flexibility in accessing funds through loans, and the investment portion offers the opportunity for returns that could outpace traditional savings methods.

Cons of an Insured Retirement Plan

1. High Fees: Life insurance policies often come with high fees, including the cost of insurance. These fees may reduce the overall returns on your investments.
2. Not Liquid: If you need to collapse the policy to access funds, you may face significant financial penalties. This makes the IRP more suited as a secondary retirement income strategy.
3. Tax Law Changes: There is a possibility that future changes in tax laws could negatively impact the tax treatment of life insurance policies, including IRPs. While the risk is low, it’s something to consider due to the long-term nature of these plans.
4. Complexity: An IRP involves multiple layers, including insurance, investments, loans, and tax strategies, which can be complex to manage without proper guidance.
5. Insufficient Funding Risk: If not funded properly, an IRP may fail to provide the expected retirement income. Some policies are sold with minimum funding, which may result in insufficient funds for retirement.

Things To Consider Before Opting for an IRP

• Policy Type: Choose between a whole life or universal life policy based on your needs. Different policies come with different growth potentials and cost
• Cost of Insurance: Understand the difference between level for life (higher initially but fixed) and annually increasing premiums (lower initially but increase over time).
• Risk Tolerance: Be aware of the investment risks involved, especially in an IRP where your retirement income relies on the performance of the underlying investments.
• Brokers and Advisors: Ensure you are working with a broker who will shop around for the best policy, as their recommendations can significantly impact your returns.

Conclusion

An Insured Retirement Plan can be a powerful tool for wealth building and tax-efficient retirement income, but it requires careful planning and consideration. It’s important to ensure that the policy is properly funded and structured to avoid any potential pitfalls. If implemented correctly, an IRP offers significant benefits, but it’s not a one-size-fits-all solution. Ensure you fully understand the associated costs, risks, and benefits before making a decision, and consult with a financial advisor to ensure it aligns with your overall retirement strategy.

This article is written for educational purposes.

Should you have any inquiries, please do not hesitate to contact us at (905) 836-8755, via email at [email protected], or by visiting our website at www.taxpartners.ca.

Tax Partners has been operational since 1981 and is recognized as one of the leading tax and accounting firms in North America. Contact us today for a FREE initial consultation appointment.