What if there were a way for you to avoid paying taxes in retirement? Thatās the promise offered by a life insurance retirement plan.
Read on to learn what money expert Clark Howard thinks about this somewhat controversial financial tool.
One of our readers named Hank wrote in to Ask Clark with the following question:
āMy wife and I recently signed up for a retirement planning class. This class was based upon the book āThe Power of Zero.ā The hope is to spread your retirement funds into three different buckets so you will avoid paying income taxes in retirement. They are pushing us to purchase a LIRP. What can you explain about this book and are LIRPs a good tool to utilize?ā
OK, letās take a step back: What exactly are life insurance retirement plans, or LIRP?
According to U.S. News and World Report, LIRPs are a kind of whole or universal life insurance policy that is marketed as being great because thereās no income limit to do one, you can make unlimited annual contributions, there are no penalties on early withdrawals and you pay no annual tax on investment gains.
But the downside is that LIRPs tend to be padded with massive commissions for the people who sell them. And as a general rule, LIRPs usually make the most sense for people who earn more than $350,000 per year because of the supposed tax benefit they offer for folks in higher income brackets.
Clark Howard has long said any insurance that has the word āuniversalā in it is radioactive for your wallet.
As mentioned before, these plans have huge commissions for the agents that sell them. But the worst part is that these policies have enormous ongoing fees and often run out of money.
If you canāt meet whatās called a ācapital call,ā where you have to come up with extra money, the account that you poured all this money into gets wiped out and then you have a giant tax liability on your hands.
With variable or indexed universal life, youāre promised ā in mind-numbing language going on for page after pageĀ ā that you get a magic policy thatās a savings account, an investment account and an insurance account all in one.
The policy illustrations show that you will pay premiums for some time and then magically the policy will take care of itself. But in practice, it hasnāt worked out that way.
In one case, The Los Angeles Times reported that a customer who was paying $25 a month for life insurance over the course of 23 years got a notice that his premium was going to $510 each month! If he didnāt pay, he would lose everything heād paid over the years and there would be no death benefit for his wife when he died.
So, thatās the quick upshot of why Clark doesnāt recommend LIRPs. You can read more about his reservations here and learn about Clarkās preferred alternativeĀ ā level-term life insuranceĀ ā here.
With level-term life insurance, you just get a simple product that pays a death benefit if you die while the policy is in force, and the price you pay never goes up. Furthermore, thereās no investment or savings component at all to complicate things.
Having said that, a couple of other potential red flags jump out right off the bat from reading Hankās email to usā¦
First off, that part about signing up for a retirement class. While itās great to broaden your understanding about retirement planning, a class may not be the best venue for that.
Why not? Simply because itās hard to know if a class is straight-up legitimate or if thereās a hidden agenda where youāre going to be sold a product or service.
Unfortunately, itās often the latter ā as in, āThey are pushing us to purchase a LIRP.ā
So remember this: If youāre attending a seminar/classĀ ā particularly if youāre lured in with the promise of a free lunch or dinnerĀ ā beware of buying a questionable fee-heavy investment from the facilitators.
That could well be the most expensive āfreeā meal youāve ever had!
When youāre looking for guidance on how to create future wealth, Clark has a kind of one-two punch he likes for you to do based on where you are in life.
Particularly if youāre younger, he recommends that you consider working with a roboadvisory firm. Roboadvisors leverage the latest in artificial intelligence and algorithm-driven portfolio management to deliver solid returns on your money, coupled with low fees.
You can see just how the low fees are from the leading roboadvisors here.
Generally, roboadvisors tend to appeal to millennials and those under 40 who are used to doing things without needing to actually sit down face-to-face with someone.
If youāre well into middle age, chances are a roboadvisor may not be your speed!
Youāre in an entirely different boat: Youāve built up substantial assets and youāre approaching retirement. In your case, thereās no substitute for sitting down with a well-trained and educated human being like a fee-only financial planner.
A fee-only financial planner can provide invaluable guidance for when youāve amassed a sizeable portfolio and itās getting closer to when youāre going to spend it.
Notice we didnāt say a word about the book The Power of Zero or the specific zero-tax strategy it advises.
Thatās because the purpose of everything Clark does is to empower you with the knowledge to make an informed judgment about the merits of the book and whether it would or wouldnāt work for you individual situation.
If youāre interested in the specifics of the Power of Zero strategy, see this thread on investment chat board Bogleheads. Many of the posters note the book is predicated on creating fear about tax rates in the future and offering a high-priced āsolutionā to that problem.
Clark, on the other hand, is an optimist by nature. His approach is more a āstay-the-courseā style of investing rather than someone who pushes fear and products that heās selling.
But the consumer champ has long said heās just one man with one point of view. Whether you choose to follow his advice or not is up to you.
āThereās no one right strategy to create long-term wealth or financial security. But there are combinations of strategies that create opportunity, real estate among them,ā Clark notes.
āAnd then thereās my belief that if you are well diversified and put money in the stock market each and every month, you have the opportunity to benefit over years from peopleās fears about being in the game.ā