What if there were a way for you to avoid paying taxes in retirement? Thatâs 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:
âMy wife and I recently signed up for a retirement planning class. This class was based upon the book âThe Power of Zero.â 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?â
OK, letâs 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 thereâs 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 âuniversalâ 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 canât meet whatâs called a âcapital call,â 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, youâre promised â in mind-numbing language going on for page after pageÂ â that you get a magic policy thatâs 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 hasnât 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 didnât pay, he would lose everything heâd paid over the years and there would be no death benefit for his wife when he died.
So, thatâs the quick upshot of why Clark doesnât recommend LIRPs. You can read more about his reservations here and learn about Clarkâs preferred alternativeÂ â level-term life insuranceÂ â 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, thereâs 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 Hankâs email to usâŠ
First off, that part about signing up for a retirement class. While itâs great to broaden your understanding about retirement planning, a class may not be the best venue for that.
Why not? Simply because itâs hard to know if a class is straight-up legitimate or if thereâs a hidden agenda where youâre going to be sold a product or service.
Unfortunately, itâs often the latter â as in, âThey are pushing us to purchase a LIRP.â
So remember this: If youâre attending a seminar/classÂ â particularly if youâre lured in with the promise of a free lunch or dinnerÂ â beware of buying a questionable fee-heavy investment from the facilitators.
That could well be the most expensive âfreeâ meal youâve ever had!
When youâre 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 youâre 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 youâre well into middle age, chances are a roboadvisor may not be your speed!
Youâre in an entirely different boat: Youâve built up substantial assets and youâre approaching retirement. In your case, thereâs 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 youâve amassed a sizeable portfolio and itâs getting closer to when youâre going to spend it.
Notice we didnât say a word about the book The Power of Zero or the specific zero-tax strategy it advises.
Thatâs 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 wouldnât work for you individual situation.
If youâre 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 âsolutionâ to that problem.
Clark, on the other hand, is an optimist by nature. His approach is more a âstay-the-courseâ style of investing rather than someone who pushes fear and products that heâs selling.
But the consumer champ has long said heâs just one man with one point of view. Whether you choose to follow his advice or not is up to you.
âThereâs 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,â Clark notes.
âAnd then thereâs 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 peopleâs fears about being in the game.â