Traditional IRA vs Roth IRA
Most folks know that both Traditional IRAs and Roth IRAs are tax-advantaged accounts for setting aside retirement savings.
The problem is that…
To gain the tax benefits they offer, you must adhere to rules regarding how much you can contribute to them based on criteria such as your age and income, along with limitations on when you can access the money.
For example, the following rules apply to these accounts:
Maximum yearly contribution for 2023 will be is $6,500 for an individual, $7,500 if you are over 50 years of age. (The IRA catch‑up contribution limit for individuals aged 50 and over is not subject to an annual cost‑of‑living adjustment and remains $1,000. Source.)
If you also participate in an employer-sponsored retirement plan, and your income is over $74,000 for individual filers and $123,000 for joint filers, you are not allowed to deduct your contribution.
If you don’t participate in such a plan but your spouse does, and you file jointly, if your joint income is greater than $203,000 you are not allowed to deduct your contribution.
All withdrawals from traditional IRAs are taxed in the year they are taken.
Contributions to a Roth IRA for 2023 are also limited to $6,500 in any year for an individual, and $7,500 if you are above age 50.
For 2023, the adjusted gross income phase-out range for taxpayers making contributions to a Roth IRA is between $218,000 and $228,000 for married couples filing jointly, increased from between $204,000 and $214,000. For singles and heads of household, the income phase-out range is between $138,000 and $153,000, increased from between $129,000 and $144,000. Source: IRS.GOV.
Unlike traditional IRAs, contributions to a Roth are not tax deductible. However, all funds withdrawn from a Roth are done so free of taxes.
Given the different treatment of withdrawals between the plans, Roth IRAs are typically favored by those who expect their income to remain at a high level or even rise in retirement, while traditional IRAs are often more attractive to those who expect their income to decline once they retire, putting them in a lower tax bracket.
What you may not know is…
That there may be another option you might want to consider…
A whole life insurance policy.
We’ll be the first to admit that not all financial advisers are going to discuss setting up a whole life insurance policy as part of one’s retirement planning, but that is often because these “types” of strategies can be a bit more “complex” than setting up a simple IRA or Roth and because not all clients will be able to pass underwriting for them due to health or lifestyle.
Which is why…
We wanted to take a moment and discuss some of the benefits of using a whole life insurance policy in place of/or combined with an IRA or Roth to help save for your retirement years. So, without further ado, let’s dive right in.
Roth IRA vs Whole life Insurance
Investors looking to put aside as much money as they can for retirement may want to take a look at using whole life insurance as a replacement for or in addition to a Roth IRA.
Given that the tax treatment of this type of life insurance is similar to that of Roth IRAs, it is worthwhile to perform a comparison of the two types of accounts.
6 Ways Whole Life Insurance is Better than a ROTH IRA
1. Funds in the cash account of a whole life policy grow tax deferred, similar to funds in a Roth, and can be withdrawn in the form of a policy loan or partial withdrawal tax free, as long as the amount withdrawn doesn’t exceed the total amount invested.
2. Unlike a Roth, contributions to a whole life policy are not limited to a relatively modest amount.
3. Also unique to whole life insurance is the inclusion of a death benefit that can increase over time and that is received free of taxes by your beneficiary or beneficiaries.
4. Whole life insurance offers a guaranteed growth rate in a policy’s cash account.
5. Participating whole life insurance also offers you the opportunity to receive dividends on your policy, and while these aren’t guaranteed, some mutual companies have paid dividends each year without fail for more than a century.
6. While funds in a Roth IRA in most cases can’t be withdrawn or accessed via a loan prior to age 59 ½, funds in your cash account can typically be accessed at any time, without government-imposed restrictions.
The Rich Person Roth
Whole life insurance is sometimes called the Rich Person Roth because it can be used for a similar purpose – setting aside funds for tax-favored growth.
In both cases between whole life vs Roth IRA, the tax-free growth of the accounts allows your money to grow faster than it would if taxes had to be paid each year.
Additionally, withdrawing funds free of taxes can benefit you by keeping your taxable income lower than it would be when receiving taxable proceeds.
Whole Life Insurance Advantage
The big advantage of using whole life insurance in the form of a Rich Person Roth over a Roth IRA is the lack of any statutory limit on the amount you can contribute to such a policy. This ability to overfund life insurance for later use makes whole life insurance an excellent means of building up substantial savings in a shorter amount of time versus a Roth IRA.
Such whole life policies aren’t necessarily just for the “rich,” either. While they do typically work best for those with substantial income, they can also be useful for individuals who started late in saving for retirement and are trying to make up for lost time and set aside significant sums of money currently but are unable to do so in a Roth IRA or other retirement account because of contribution limits.
If you are making over $100,000 a year the likelihood is that the Roth contribution limit does not allow you to set aside enough funds to cover your retirement needs, especially if you are getting a late start on saving for retirement.
If you are in this position, using dividend paying whole life insurance to set up a Rich Person Roth can expand your ability to put aside tax-favored funds for retirement.
Guaranteed Growth & Premiums
While whole life cash account policies may not offer the same upside growth potential as investments in the stock market through mutual funds or similar vehicles, the guaranteed nature of the growth they offer means that they are not subject to the same risk.
A well-designed whole life policy can create cash value in year one, and gradually add increasing sums to the cash value account over the policy’s life span, producing returns that in recent years have compared favorably with other cash equivalent alternatives.
Some claim that it is better to buy term life insurance and invest the difference instead of whole life, however, besides the fact that this would result in tax consequences on any income earned on the difference (on sums not invested in an IRA or other retirement plan), there is also the issue of the increasing cost of term insurance as you age.
A whole life policy offers a premium payment and death benefit that is guaranteed for life as long as premiums are paid. This differs from term life which is inexpensive when you are young but becomes more and more expensive as the years go by, in many cases resulting in greater total expenditure on life insurance over the long-term.
Many people are aware that Roth IRAs offer creditor protection on a state by state basis. However, you may not be aware that a huge advantage of whole life insurance is the creditor protections offered as well.
Life insurance creditor protections vary state to state, but many states will provide 100% exemptions for the cash value in your whole life policy, as well as protection of the death benefit paid to your beneficiary.
For example, if you are a Florida resident and you are being sued for negligence or you are filing a personal bankruptcy, under Florida law your cash value may be 100% protected from all creditors. As always, when it comes to legal matters, please check with a local attorney-at-law.
Life Expectancy Considerations and Zero Net Loans
An individual’s life expectancy should be considered when evaluating the use of whole life as a source of retirement savings. Generally, the longer tax-deferred compounding has to work, the more advantageous it is.
Also, the impact of the cost of funding the life insurance portion of your whole life policy should be taken into account as well. The longer your funds grow tax-deferred, the less impact such fees have.
Generally, those with poor health will benefit less from a Rich Person Roth, as they will have less time to benefit from tax-deferred compounding. However, if you are in poor health, the life insurance coverage provided by whole life is likely to be more valuable than it would be for someone in excellent health.
Withdrawals are free of taxation from life insurance policies as they are considered to be loans taken against the death benefit guaranteed by the insurance company.
Thus, the insurance company will charge an interest rate for the loan. This interest can be offset by interest credited on the funds still invested in the policy.
Because of this, it makes sense to look for policies that offer Zero Net Loans, where the interest you pay on the loan is fully offset by the gains on the funds invested in your policy’s cash account, resulting in zero net interest costs.
For more information about how a whole life insurance policy can help you meet or exceed your retirement goals, feel free to give us a call and let us know how we can help you out!