Roth IRAs vs. Life Insurance: Which Is Right for You?
Roth IRAs vs. Life Insurance: Which Is Right for You?
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Written by powherhousecoach

April 27, 2022

Roth IRAs vs. Life Insurance: Which Is Right for You?

When it comes to where to allocate your money, there are a lot of options available to you. One controversial debate people have is whether they should put money into a Roth IRA or purchase life insurance. Both have their pros and cons, so it’s important to understand the difference before deciding.

Roth IRAs

A Roth IRA is an individual retirement account that offers tax-free growth and tax-free distributions in retirement. The money you contribute to a Roth IRA is after-tax dollars, but you won’t pay any taxes on the money when you withdraw it in retirement. This makes a Roth IRA an attractive option for people who expect to be in a higher tax bracket in retirement than they are currently. Since you won’t have to pay any taxes on the money when you withdraw it, it can be a great way to save for retirement.

Here are the Roth IRA advantages in a nutshell:

  1. Tax-free growth: The money you contribute to a Roth IRA grows tax-free, which can help it grow faster than if it were in a taxable account.
  2. Tax-free distributions: You don’t have to pay any taxes on the money you withdraw from a Roth IRA in retirement, which can save you a lot of money in taxes.
  3. No mandatory withdrawals: Unlike other retirement accounts, there are no mandatory withdrawals from a Roth IRA. This means you can keep the money in your account and use it for as long as you want.
  4. Flexible Contributions. One of the biggest benefits of a Roth IRA is that you can contribute as much or as little money as you want. There’s no minimum contribution, and you can adjust your contributions up or down depending on your budget and financial situation. This makes a Roth IRA a flexible option for saving for retirement.

So, what’s the catch? Here are some disadvantages of investing in a Roth IRA:

  1. Contribution Cap. The main disadvantage of a Roth IRA is that you’re limited in how much money you can contribute each year. The maximum contribution for 2022 is $6,000, and if you’re over 50, you can contribute an additional $1,000. This can be a disadvantage for people who want to save more for retirement.
  2. You can’t exceed the income threshold. Another disadvantage of Roth IRAs is that you have to have taxable income in order to contribute. If your income is too high, you may not be able to contribute to a Roth IRA. This can be a disadvantage for high-income earners who want to save for retirement.
  3. Market Risk: ROTH IRAs need to be invested properly in the market for your time horizon and risk tolerance. You run the risk of losing money in the market as with all investments.,

Life Insurance

Life insurance cash value can be another source of funds in retirement. Life insurance policies are funded with after-tax dollars and borrowing money from the policy is tax-free. The death benefit also pays to your beneficiaries income tax free. This means money goes to your loved ones in a very tax efficient way!

What are the advantages of life insurance? Here’s a quick breakdown:

  1. Tax-free distributions: You don’t have to pay any taxes on the money you borrow from a life insurance policy in retirement, which can save you a lot of money in taxes.
  2. No mandatory withdrawals: Unlike other accounts, there are no mandatory withdrawals from a life insurance policy. This means you can keep the money in your account and use it for as long as you want. You can also borrow and put the money back in as many times at you like.
  3. No market risk: With a whole life policy, the value accumulated is not tied to the market in any way so it can only go up in value or stay the same over time when the market fluctuates. It can be a good way to offset risk in other accounts. 
  4. Death benefit: Life insurance passes to your beneficiaries income tax free. Which means that it’s a really tax efficient way to leave money to your loved ones. It also gives you the ability to spend all of your retirement funds knowing that you will have in influx of wealth when you pass on.

And the downside of life insurance is?

  1. Cost: Life insurance policies can be expensive because you aren’t just accumulating assets you can access, there is also the death benefit component.
  2. Not available to everyone: Life insurance requires medical underwriting. Not everyone is able to obtain a policy due to their age and or health. It’s important to consider insurance as early as you can.
  3. Risk of Lapse: Its important to be careful to not borrow the full amount of the cash value because this will cause the policy to lapse (no more death benefit) and could create a taxable event.

So which is right for you? It depends on your individual situation.

If you’re eligible to contribute to a Roth IRA and you expect to be in a higher tax bracket in retirement, a Roth IRA is a good option. It offers tax-free growth and distributions in retirement, and the money you contribute is after-tax dollars. Also, Roth IRAs are generally less expensive, so if you’re looking for a low-cost option, a Roth IRA may be the better choice.

However, life insurance is a good option if you need access to cash in retirement, want to protect your loved ones, or you want to borrow against the policy to use as retirement income.

The answer may be: BOTH! Life insurance and ROTH IRAs are both great financial tools to use as part of your financial portfolio.

Need help navigating your retirement plan? We’ve got you covered! Book a discovery call with us to learn more.

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