People have several options when it comes to saving for retirement. The most common retirement savings option are 401(k) plan or individual retirement accounts (IRA).
The main benefit for using a 401(k) or IRA is contributions are typically made on a pre-tax basis and any investment gains are non-taxable until distributions occur. The downside of using these as a retirement savings vehicle is distributions are fully taxable.
This means that any money you receive during retirement from a 401(k) or IRA is going to be taxable at ordinary income tax rates. This may not be a problem for many people as people tend to be in a lower tax bracket during retirement.
It is for this reason people today are using Roth IRAs. A Roth IRA is a retirement savings vehicle where contributions are initially made on an after tax basis (unlike a Traditional IRA). What makes the Roth IRA is distributions during retirement are tax-free.
The Roth IRA is a great benefit for individuals looking to accumulate assets for retirement that are interested in income that is non-taxable (or tax-free).
Similar to a 401(k) or Traditional IRA there are limits to what you can contribute. There are also limitation or penalties that you will incur if you want to access the money prior to age 59 ½.
When planning for retirement it is important to have three different types of assets. When we say this we are not talking about it in the traditional sense of stocks, bonds, and cash. We are talking about it from the perspective of how the asset is taxed during retirement.
Every family should have retirement assets that fall into the following three categories:
- Taxable as Ordinary Income
- Taxable as Capital Gain
By having retirement assets in each category, it will allow you to pick and choose what assets to access based on the tax environment at that time. In times of high taxes, you will want to access your tax-free retirement assets. In times of low taxes, you will want to access you retirement assets that are taxable at ordinary income tax rates.
When you reach age 72 you will be forced to take Required Minimum Distributions (RMD) from your 401(k) and Traditional IRA accounts. The RMD will be based on the account value and your age.
A Roth IRA does not have Required Minimum Distributions. The challenge with a Roth IRA is the annual contribution limits may not be enough for you to save enough money to cover all of your retirement needs. It is for this reason some people use a life insurance retirement plan.
A life insurance retirement plan (or LIRP) works similar to a Roth IRA. Contributions are made on an after-tax basis and you are able to take distributions on a tax-free basis during retirement.
The main difference between a Roth IRA and a LIRP is the LIRP has a death benefit. The can be beneficial if you pass away prior to retirement as it will provide a tax-free death benefit to your spouse that they can use.
When considering a life insurance retirement plan it is important to evaluate different policies. You should specifically look at the fees and expenses of the policy to make sure you are able to access the most amount of money.