 Personal Finance PowerPoint Presentation. IRA, IRA vs. Life Insurance for Retirement Saving. Prepare to get financially fit by practicing personal finance. Insurance is part of our long-term risk mitigation strategy where we follow the adage of measure twice, cut once, put in a formal process in place, look in something like set the goals, develop a plan to reach them, put the plan in action, review the results and repeat the process periodically. Most of this information can be found at Investopedia, IRA vs. Life Insurance for Retirement Savings. What's the difference? Which you can find online. Take a look at the references, resources, continue your research from there. This by Daniel Kurt, updated January 19, 2022. In prior presentations, we've been taking a look at insurance in general, moving to life insurance. As we think about life insurance, we want to think about the two major categories of life insurance being term or pure life insurance versus the permanent life insurance. Always comparing and contrasting to the term or the pure insurance because that can be used as the baseline or ruler keeping the adage in mind of I'm going to buy just the baseline term insurance, which is typically cheaper and then invest the difference into some kind of investment savings for things like retirement and possibly getting a tax advantage to do so, but still putting the money into 401K plans or an IRA or something like that. Now we might get more complex insurance strategies, which are the permanent insurance, which has an investment component to it, but we always want to be comparing and contrasting back to that adage. Why don't I buy the cheaper policy, which is just the life insurance and then invest the difference? Why am I kind of commingling the insurance along with the investment? And so you have to have some kind of rationale for that. That's how I would think about your planning and your strategy. And there could be rationale for it. For example, you might have more complex tax planning strategies. You might, for example, have maxed out a 401K or IRA contribution, and therefore it might be more reasonable to do something like that if you have the money to do something like that, or you might have like a state tax planning strategies for example. So when saving for retirement, a 401K plan is a great place to start, especially if your employer matches a portion of your contribution. If you are working somewhere and your employer gives you a 401K, that's usually a huge benefit and it usually has a pretty high maximum amount that you could put into the 401K. They might match the amount in the 401K, which is huge, and you get a tax benefit for the amount that you put in because you might not be taxed at the point in time that you put it in and the income that is generated, dividends, interest, for example, typically not taxed until you pull it out at the point of retirement. So if you have some extra money, then you might be saying, well, if I don't have the cash flow, which many people don't, to maximize out my 401K plan, and the choice is, do I want to buy a more expensive insurance policy that has an investment component to it, or do I want to buy the term policy, which is typically cheaper, so I have the insurance and then invest in my 401K plan, it might be a good thing to invest basically in the 401K plan because of the number of benefits of tax savings you get with relation to it. It's also a little bit more less complex given the fact that you're buying just insurance and then your 401K plan is clearly just for retirement. But where do you go once you've contributed the maximum amount for the match or if your place of employment doesn't offer a qualified plan, a retirement plan? In other words, you might have a 401K plan but there's some limit in terms of how much you can put into the 401K plan and get that benefit in terms of the tax benefit or you might not have access to a 401K plan in which case it might be advantageous to try to buy more complex insurance in that case to get some kind of tax benefits on the life insurance side of things as opposed to simply purchasing the term insurance. But this is probably the case for more complex tax strategies most likely for more wealthy individuals. Many workers continue to fund their workplace plan but there are other options including using a life insurance policy in certain cases the insurance as investment approach can be a wise move but usually for wealthier investors. So now we're thinking about the insurance not so much as just life insurance but also as an investment tool. So however, investors who have maxed out their allowable 401K and individual retirement accounts that's the IRA contributions. So then if you don't have the 401K plan or sometimes you could still put money into an IRA if you do have a 401K plan but there's a much lower maximum on the IRA in terms of how much you can put in and still get a benefit in terms of lowering your taxable income in essence for the point in time that you put the money in although you might still get a benefit in terms of the growth of a retirement plan like a 401K and an IRA even if you don't get that initial deduction if you're still allowed to put money in that should evaluate whether the sizable fees of life insurance policies would outweigh any potential tax benefits. So you could put money into the life insurance as kind of an investment tool strategy but usually it's going to cost more to do that because the life insurance is a more complex tool so if you're doing it just for the tax benefit it might be more beneficial if you have access to these other tools the 401K plans then the life insurance if you've maxed out these other tools then you might consider using the life insurance more like an investment. So an IRA can grow in a tax advantage way for disbursement later in life that's kind of a point in an IRA you get a benefit when you put the money into an IRA and then it can grow without being taxed on it until you take the money out allows tax deferred growth in investments which are then subject to income tax upon withdrawal in which come with penalties for early withdrawal. So in other words you've got the money under kind of like the umbrella of an IRA so it's still invested in just normal stuff whatever you would invest in if you were saving for investments or retirement without an IRA stocks bonds savings accounts but it's under like an umbrella you can think of it meaning that if you took the money out for no reason then you would have to pay generally a penalty on it that restriction is the price that you pay in order to get the tax benefits so withdrawal in retirement after reaching age 59 and a half or taxed at your income tax rate so when you take the money out after 59 and a half you're typically going to be taxed on it meaning all the growth and the money that you put in there was basically deferred for tax purposes and then taxed when you take it out there are annual limits on how much you can contribute so there's going to be a limit in terms of how much you can put into the IRA and that's where you get this point where you might max it out if you've got substantial cash flow which you possibly only have if you're fairly well off you would think then on the life insurance side of things can build to an accumulate retirement savings and disperse funds tax-free if designed correctly so in other words you're trying to use the life insurance as basically another kind of a savings tool as opposed to just purely life insurance and possibly if you're able to design things in such a way that you can get the tax-free distributions that would clearly be a benefit. So it may benefit the wealthy so this would typically be more of a complex financial strategy that might be more useful if you have the cash flow in order to do it possibly in situations where you've maxed out other tax-benefit options like an IRA or a 401k plan can make a periodic withdrawal as long as you don't pull out more than what you paid in premiums and you won't experience a tax hit so that's one of the benefits with the life insurance is that if you've got the money and that kind of tax component of it you might be able to access it in the case of an emergency a little bit more easily without being penalized than if it's under the umbrella of an IRA even if you can't pull it out directly you might be able to take a loan against it which is kind of similar to pulling it out might be subject to interest if you were to do something like that surrendering your policy decreases the death benefit for errors and you may lose coverage altogether so IRA or 401k between these two strategies the IRA is a more straightforward way to save for retirement so when you're thinking about saving for retirement if you have access to a 401k that's usually the way to go these two tools are similar in nature but the 401k usually has a larger amount that you can put in to it and it might have a matching component which often makes it more beneficial than an IRA so you create an account with a broker firm mutual fund company or bank and select the investments you'd like to make with your contributions so both of these tools you can think of them as just kind of an umbrella the actual investment tools underneath that umbrella are just like anything else if you had money where would you put it stocks, bonds, IRAs ETFs what not so those are the same tools they're just under the umbrella of these IRAs which basically means they're restricted you pull them out but you get a tax benefit for doing that and incentive by the government to try to get you to save for retirement so these can include everything from individual stocks to mutual funds and gold bullion so features and tax treatment the main perk of these accounts is their tax treatment which is similar to 401ks so with a traditional IRA your qualified contributions are tax deductible and the investment grows on a tax for basis so when you put the money in you get a tax benefit because you basically get to lower your taxable income or you can think of it like a deduction and so that's going to give you a tax benefit at that point and the growth is something that you're not paying tax on the dividends and interest until you pull the money out withdrawals and retirement after reaching age 50.5 or taxed at your income tax rate so a Roth IRA is similar but the tax treatment and benefits are different so the Roth IRA is kind of like a reverse traditional IRA so it's a little bit it's like a backwards IRA meaning you don't get the tax benefit up front but when you pull the money out then you don't have to pay taxes on it and the growth on the money then is where you get the benefit on the Roth IRA so you invest using after tax dollars meaning there's no tax deduction and the year of contribution however you don't pay a dime you don't have to pay taxes on the accrued funds so which is great so you pull the money out that means dividends and interest and what not have gone up and you're not paying the taxes when you pull it out even on the gains not simply just the principal which is what you would typically think of in a normal investment so as long as you've owned the account for at least five years and have reached age 59.5 before making a withdrawal so contribution limits there are annual limits that can be deposited into an IRA for the 2021 and 2022 tax year the annual contribution limit for traditional and Roth IRAs is $6,000 and if you're age 50 and over you can contribute another $1,000 called a catch-up contribution for non-Roth 401K plans the maximum contribution for the 2021 tax year is $19,500 so you can see that the 401K plan is substantial the 401K plan it's less likely that most people are going to max out the 401K plan unless you've got a significant amount of cash flow that's why more advanced strategies above and beyond maxing out the 401K plan are more likely to apply to more wealthy individuals and for 2022 it's $20,500 plus a $6,500 catch-up contribution for each year is allowed for those 50 or older so after retiring you get an ordinary income tax on whatever amount you withdraw permanent life insurance another possible route is to buy permanent life insurance in addition to offering a death benefit for your survivors these policies also feature a saving component part of your premium goes towards your death benefit another portion builds up your cash value account which grows on a tax deferred basis so now you've got the insurance and you've got that kind of investment component which has that same kind of tax deferred investment strategy in a similar fashion to like the retirement instruments for example on the growth component so for life insurance whole life insurance permanent life insurance policies are a little complicated this is one of the downsides of course you're getting into a more complex strategy instead of just separating these things out as you would do if there wasn't some your tax thing that possibly could make it advantageous to do a more complex convoluted strategy so each time you pay a premium part of it goes towards a cash value account with a whole life insurance policy that carry your credits your account by a certain percentage based on how its own investments perform so if you've had your policy for a few years you'll typically see annual returns in the 3% to 6% range often earned in tax free investment variable life insurance other types of permanent life insurance work a little different for example with a variable universal life insurance that's the VUL policy the amount of the credit is tied to the performance of stock and bonds funds of your choosing we talked about these in a bit more depth in prior presentations if you want to take a look at them in more depth the potential returns are higher but so is the risk if the market loses ground over a given period you may have to pay a higher premium to keep your coverage in place paid up additions investors who rely on life insurance for retirement needs should think long term it can take 10 to 20 years to build up a sizable cash value account so these are types of strategies that might be long term kind of strategies that will start to pay off over a longer window or range of time once your balance is big enough there are a few ways you can draw on your policy for personal needs paid up additions PUA are a good way of increasing the amount of cash value in a policy for low relative cost which can maximize retirement income periodic withdrawals another possibility is to make periodic withdrawals as long as you don't pull out more than your basis that is how much you paid in premiums you won't experience a tax hit for doing so so any additional amount is subject to ordinary income tax rates to keep the internal revenue service IRS at bay some folks stop making withdrawals once they reach their basis from there they take out a loan against their policy which is usually tax free surrendering your policy yet another option is to surrender your policy and get the cash value in one lump sum but there's an important catch anytime you take money out you're decreasing the death benefit for your heirs so there's going to be a relationship between the cash value and the death benefit the amount that your heirs would get in the event of death if you take a loan against your policy you have to pay it back with interest to build it back up again so if you take the loan you can use the cash value as collateral but and that's not going to be generally counted according to the IRS because you didn't really pull the money out and but you might have to pay interest on it because it's structured of course as a loan at that time so and if you surrender it you'll probably lose your coverage all together compare this to someone who buys a much cheaper term life insurance policy which has no saving feature and invests the difference in an IRA so that's always what you want to basically be comparing against you're going to say okay I could buy just term life insurance which is just I'm just buying life insurance and I can invest the difference and say an IRA or a 401k plan or I can try to get into kind of some more complex strategies with more complex insurance tools which are basically getting into an investment and life insurance component again possibly those becoming more beneficial at the point where you're not getting as much benefit putting the money into say an IRA or a 401k plan possibly because you're hitting the max possibly because you have or you're fairly well off you got a good cash like a lot of cash flow so they can dip into their savings at any time after age 59 and a half without affecting the insurance or it's payout if you die and they can leave any remaining balance to their family members which can't be said for your cash value account a costly approach perhaps the biggest knock on permanent life insurance policies is their upfront cost first there's the initial fee that helps pay the agents commission so obviously setting up this kind of more complex type of tool that has these different components to it is going to be a bit more costly than setting up just an IRA which is just like an investment that's under this umbrella of retirement thing so often this can eat up half of your first year premiums consequently it takes a few years for your cash value account to start growing so it's possibly more of a long-term strategy on top of that policy holders tend to face deep investment fees often around 3% per year so again if you just invest in like an index funds for example then you would think that the cost of the expense of the investing in it the pain for the maintenance of the investment will not be as high you would think as a more complex set up insurance kind of plan so by contrast the average expense ratio in 2020 for open in mutual funds and ETS offered for sale was 0.1 0.41% so significant difference to the 3% so investing in an IRA allows you to eliminate this significant drag on your returns but that's not all you also have to worry about surrender charges if your policy lapses within the first few years you'll lose not only your death benefit but also a considerable portion of your cash balance as well most policies the amount of this fee gradually decreases over a period of years and then disappears however if you are committed to long-term strategies permanent life insurance policies designed to accumulate extra cash value will tend to break even around the 10th year of the policy so more long-term strategy possibly for people with with significant cash flows moreover cash is accumulated every year before that so if you did surrender the policy you would receive some money back and not be out of the entire amount of premiums you have paid so when insurance as an investment makes sense when does it make sense to do this more complex strategy and not just by the simple term insurance and invest the difference does it ever make sense then to use life insurance as an investment the answer is absolutely in some limited cases so for example wealthier individuals will sometimes set up what's known as an irrevocable life insurance trust so their heirs can avoid estate taxes so now we're getting in to the estate tax planning which again is typically for more wealthy individuals that are going to be taxed when they die you die and the wealthy individual die and the IRS goes over and rolls the corpse over and strips of naked and make sure there's does a cavity search for diamonds or something so in any case so in order to avoid that technically the trust is made for premiums for the life insurance policy so the death benefit isn't considered part of the deceased family members estate so beyond that life insurance is sometimes a reasonable choice for every day investors who have maxed out their allowable 401k and IRA contributions that still a significantly high category especially for a 401k you gotta have significant cash flow to kind of be able to do that but if you have that cash flow then it becomes possibly more advantageous at that point but even then it's worth evaluating whether the sizable fees outweigh the potential tax benefits so then again you got more complexity you got sizable fees related to it so is that is that worthwhile given the fact that you might get some tax benefit it's not a straight forward tax benefit in other words is putting money under the umbrella of a 401k or an IRA agents make a lot of money selling the idea that insurance is a great way to save for retirement so clearly if you're talking to an agent they're going to make a commission so they're going to be invested in the idea that this is a good tool and possibly sell it to people that are not in that kind of niche area where it would be more advantageous because they don't have the cash flow to max out their IRA or 401k plan for example but given the considerable cost of these policies you're probably better off purchasing low cost term policy investing in something simpler like an IRA investopedia does not provide tax investment or financial services and advice so this isn't this isn't advice as we're just talking here the information is presented without consideration of the investment objective risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors so disclaimer disclaimer here investing involves risk including the possibility of loss of principal investors should consider engaging a financial professional to determine a suitable retirement savings and investing strategy and when you do that you typically want to be talking to someone who's not making commission based on the things that they're going to invest you in at least in part so a CPA a financial planner that's not tied to an insurance company for example a lawyer or something like that possibly paying them just for advice so that you then can depend on their advice being dependent and then talk to the brokers and what not and the insurance companies