11 May 2012 0 Comments

An Alternative To The Roth IRA

This is my first entry on the uses for Permanent Life Insurance.

The Roth IRA has become a popular retirement plan.  Contributions to the Roth IRA are not tax deductible, but earnings on investment grow tax free and at retirement income is received tax free.  Here’s an interesting alternative or supplement to the Roth IRA using an Indexed Life (IL) Insurance policy…

Our example is a male, age 35 who is thinking about contributing $5,000 per year to a Roth IRA.  He has a couple of young kids, so life insurance is important. Instead of the IRA he purchases a $444,451 Indexed Life (IL) insurance policy for a $5,000 annual premium through age 65.  That’s the maximum premium allowable without creating a MEC.* Like the deposit to the Roth IRA, the IL $5,000 annual premium is not tax deductible, but the earnings grow tax free in either the IRA or the IL policy.  However, if he dies with an IRA, only the value of the investments is there for his family, but the IL policy produces $444,451 tax free.

What happens at retirement with the IL policy?  Based on non-guaranteed current values, $25,000 per year of tax free funds could be received from the IL policy from age 65 through age 100, plus an additional tax free death benefit.  That net death benefit would have grown to $547,000 at age 65 and to $1,200,000 by age 85.

Income from the IL policy is tax free because it is obtained by withdrawing up to the basis and then borrowing.  This Roth IRA alternative is not without risk.  The income and death benefits above the initial amount are hypothetical.  Actual values will depend on performance and insurance company charges.  Additionally, there are two major concerns when using the IL policy:

  • If you don’t keep paying the premium you will lose substantial money in the early years.
  • If your policy lapses because you miss premiums or withdraw too much cash you would have to pay income tax in that year on the total gain.

As long as you manage the IL policy carefully, however, it is a viable alternative or supplement to the Roth IRA.  You’ll still need a term insurance program for total family protection.  Don’t add that coverage to the IL policy.  Term Insurance is more efficient for pure death benefit needs.

*See glossary for definition of MEC.

Next, it’s on to our second need for Permanent Life Insurance:  Pension Maximization.

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