The Roth Individual Retirement Arrangement, or Roth IRA, and cash value life insurance share a valuable investment feature. They are the only two accounts in America that grow your investments completely tax-free. However, they also have some significant differences that you need to consider when you choose between the two.
The IRS restricts who can invest in a Roth IRA. If you make too much money, you can't use this account. As of 2012, if you are single and make over $125,000 per year or are married and make over $183,000, you are ineligible to use the Roth IRA. There is no income restriction on cash value life insurance. You can use this investment no matter how much you make.
There is also a limit to the amount you can put in a Roth IRA per year. As of 2012, you can invest up to $5,000 per year into your Roth IRA. When you turn 50, you can invest up to $6,000. There is no limit to the amount you can invest in whole life insurance. If you want to invest more money, you just need to buy more life insurance.
When you invest in cash value life insurance, your are also buying a life insurance policy. This means you get insurance protection on top of your investment gains. If you die early, your heirs get a large death benefit. If you die while investing in the Roth IRA, your heirs only get your savings. However, to invest in cash value life insurance, your health needs to be good enough to qualify for a policy. If your health is poor, you could get rejected by insurance companies.
To get the tax-free benefit of cash value life insurance, you need to keep your insurance policy active every year. This is an extra annual cost. Life insurance has a lower annual return than a typical Roth IRA -- in some cases, much lower -- because you need to use part of your annual gains to pay for the insurance.
The Roth IRA limits when you can take out some of your money. You can pull your contributions out at any time without paying taxes or penalties on them, since you paid tax on them before you put them in. Since it's a retirement account, though, the IRS will charge income tax plus a 10 percent penalty on your earnings if you withdraw them before age 59 1/2. There are no restrictions on when you can take money out of life insurance, making it useful for early retirement. However, if you make a straight withdrawal from your cash value, you will owe income tax on your investment gains. For your life insurance investment gains to be tax-free, you need to take a loan from your cash value, not a withdrawal.
The IRS doesn't tax life insurance policy loans. As long as you keep the insurance policy active, you won't owe any income tax. When you die, the loan will be paid back out of your death benefit. However, by taking a loan, you are reducing the inheritance for your heirs. If you want to go back to the original death benefit, you need to pay the loan back with interest. The Roth IRA doesn't let you take loans. Once you take money out of the account, you can't put it back in.
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