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Choosing between investing money into a retirement account or a life insurance policy can be a tough decision. Our guide to life insurance vs. IRA retirement savings will help you decide where you should put your money.
What is Life Insurance?
Life insurance is an agreement between a policy holder and an insurance company to provide a death benefit to a designated party if the policyholder dies while the policy is active. A life insurance policy ensures that a designated beneficiary or set of beneficiaries, is provided with a lump sum equal to the amount specified as the death benefit in the initial contract of the policy. The beneficiary is chosen by the policy holder when they sign up for coverage.
The policy holder pays a certain amount of money in monthly premiums to uphold the policy for as long as determined or until death. The amount paid in premiums is determined by the type of policy and the amount of coverage the policy holder chooses.
There are a variety of different types of policies, and additional factors (like health and hobbies) are also taken into account when calculating coverage eligibility and premiums.
What is an Individual Retirement Account (IRA)?
An individual retirement account (IRA) is an investing account that lets you save and invest money for retirement with some tax advantages. You can open an IRA and invest in assets like stocks, bonds and ETFs. The growth of your account balance will depend on how much you invest over time and how much money you contribute to your IRA.
There are several types of IRAs, which include the traditional IRA, Roth IRA, SEP IRA and a simple IRA. The type of IRA you open will usually depend on your lifestyle and income, as well as whether you have a retirement plan at work.
For example, if you’re closer to retirement, you’ll usually want to choose a traditional IRA to avoid taxes on payments when you’re earning more. If you’re just getting started in your career, you can usually save money by paying taxes now and avoiding them when you take disbursements through a Roth IRA.
Main Differences Between Life Insurance and IRAs
Whether you decide to start an IRA or take out a life insurance policy can be heavily influenced by the differences between the two. The differences could lead to leaving nothing to your survivors or leaving them to live a comfortable life.
When comparing life insurance and IRAs, contributions to life insurance policies are much more set in stone. If you make less money in a given year or you run into unexpected expenses, you can choose to not invest in your IRA that year. However, you cannot choose to not pay your annual premiums for life insurance. Missing even a single monthly premium payment gives your insurance the right to cancel your coverage.
Roth IRAs have an annual contribution limit of $6,000, which can be increased to $7,000 if you’re over the age of 50. Select IRAs are also limited by constraints of your income. For example, your income as a single filer must be less than $140,000 for the 2021 tax year in order to contribute to a Roth IRA.
Life insurance policies can be structured to have no contribution limits. They can accept more than IRAs in annual premiums, a process known as “overfunding” your policy. Life insurance policies also have no rules on what type or amount of income you must have in order to take out a policy. You can pay your annual premiums using accrued interest, dividends or any other form of income aside from an earned income. Life insurance policies also have no constraints on income and policy choice like IRAs do.
Life insurance policies are affected by your insurability. This means that you could be denied a life insurance policy entirely if the insurer decides you are not insurable. This could be due to your health, lifestyle, age or even your family history. In addition, the premium you pay can also increase with age or health, leaving there to be less certainty.
While these risks are not a concern with an IRA, you still have to consider the volatility of the market. IRA contributions may be subject to market decreases and increases depending on the investments you chose. If the market goes down, your IRA could go down in value as well.
Estates Always Consider Roth IRAs
Roth IRAs will always be included as part of your estate’s valuation. The federal exemption amount of $11.59 million is for estate taxes. This means that if your IRA holds more than $5.49 million in value at the time of your death, your beneficiaries will need to pay taxes on your holdings. Most accounts won’t reach this amount, however, and some states have their own estate taxes that you need to consider.
Life insurance payouts can be structured in a way that ensures that the policy isn’t considered part of your estate. Naming an individual or group of individuals as the beneficiary on your policy allows them to avoid taxes on your life insurance policy, as the payout is not considered to be property of your estate.
If you’re particularly concerned about being able to leave money to your loved ones after you die, you should consider a life insurance policy. Many retirees vastly underestimate what it costs to make it through retirement. If you only depend on an IRA, you could drain all of the money in your account on daily living expenses through retirement, leaving you with nothing left to provide to your beneficiaries.
You are able to take out periodic withdrawals from a life insurance policy as long as it is not more than your “basis,” which is how much you pay in premiums. If you exceed your basis, then it is subject to taxes. You’ll need to have a whole life insurance policy if you’re interested in periodic withdrawals — these types of policies have cash-value components that term life insurance policies do not offer.
Though you can withdraw money from your IRA before retirement, you’ll be subject to a 10% penalty on any funds you take. Early withdrawals from your account may also be considered as part of your gross income when calculating tax dues depending on the type of policy you have.
When it comes down to it, you don’t have too much control over your IRA. Most IRAs are paid with pre-tax dollars, so you accumulate wealth on a tax-deferred basis. However, your distributions are still taxed if you choose a traditional IRA.
If you choose a Roth IRA, you’ll pay taxes on the money that you contribute but your holdings grow tax-free. There is no flexibility when it comes to paying taxes on both these account types. However, you can choose individual investments contained within your portfolio.
Life insurance policies are paid for with post-tax dollars. You may accrue interest and dividends through a whole life insurance policy. In addition, so long as you avoid assigning your estate as the beneficiary of the policy, your loved ones won’t need to pay taxes on your death benefit.
There are ways that you can protect yourself against loss when investing with an IRA. Be sure to select a diversified range of assets and rebalance your portfolio to fit your risk tolerance needs as you age. You might also want to speak with a financial planner when choosing your investments to be sure that your portfolio contains the right level of diversification.
Get Professional Advice
IRAs and life insurance policies can both be complicated. Consider consulting with a finance professional in order to structure either in a way that’s most beneficial to you, your family and your goals after you die.
Best Life Insurance Companies
The company that you purchase your life insurance policy is almost as important as the policy type you choose. Consider starting your search with a few of our favorite providers below.
- Best For:Those Under 50 Years Oldsecurely through Wysh Life Insurance's website
- Best For:Adjustable coveragesecurely through Ladder Life Insurance's website
Ladder Insurance Services, LLC (CA license # OK22568; AR license # 3000140372) distributes term life insurance products issued by multiple insurers – for further details see ladderlife.com. All insurance products are governed by the terms set forth in the applicable insurance policy. Each insurer has financial responsibility for its own products. Coverage amounts vary by state.
- Best For:Under Age 64
Haven Term is a Term Life Insurance Policy (ICC21 Haven Term in certain states, including NC) issued by C.M. Life Insurance Company (C.M. Life), Enfield, CT 06082. In New York (DTC-NY) and California (DTC-CA), it is issued by Massachusetts Mutual Life Insurance Company (MassMutual), Springfield, MA 01111-0001.
- Best For:Young familiessecurely through Fabric Life Insurance's website
- Best For:Term life insurancesecurely through Bestow Life Insurance's website
*excludes New York
- Best For:People with healthy lifestylessecurely through Sproutt Life's website
Best Retirement Advisors
Saving for retirement can be a confusing process. A personal retirement advisor can help you create the ideal plan for your individual needs and ensure that you’ll have enough money to enjoy your golden years. Browse a few of our favorite retirement advisors below.
Creating a Plan For the Future
If it’s very important to leave money behind to beneficiaries when you pass, you might want to consider investing in both an IRA and a life insurance policy. Retirement savings alone may not provide you with sufficient funds to live retirement the way you’d like to while also ensuring a legacy for your loved ones. Think of an IRA as an investment in yourself and a life insurance policy as an investment in your loved ones’ future.
Frequently Asked Questions
Is an IRA the same as life insurance?
No. An IRA is an account that you can use to save for retirement with tax advantages. A life insurance policy is a type of insurance that provides a named beneficiary with a lump-sum cash payment if you pass away while the policy is active.
Can I buy life insurance in my IRA?
You cannot currently buy life insurance within the bounds of your IRA.
Benzinga crafted a specific methodology to rank life insurance. To see a comprehensive breakdown of our methodology, please visit our Life Insurance Methodology page.
About Sarah Horvath
Sarah is an expert in the insurance, investing for retirement and cryptocurrency space.