American workers have more than $2 trillion invested in IRAs, according to research firm Cerulli Associates. IRA investment is expected to grow faster than 401(k) growth through the year 2022. That's because not all employers offer 401(k)s, and when people leave a job, it's easier to roll an old 401(k) into an IRA instead of waiting for the next 401(k) opportunity to come along.
But what if an IRA isn't the best way to save for retirement? Let's find out.
How a Traditional IRA Works
A traditional IRA is funded with pre-tax dollars. As of 2014, you're allowed to contribute up to $5,500 per year through the age of 50, and then $6,500 each year afterward. You don't pay tax on the money you contribute to your IRA, and that money grows without being taxed, either. It's designed to help you save a nice chunk of change for retirement, with the assumption that you can't afford to pay tax now, but you will be able to afford that tax later. When it's time to retire and you begin taking distributions, those payments are taxed as ordinary income. Just don't take any of that money out before age 59 and a half, or you'll incur a 10% "early withdrawal" penalty!
It sounds reasonable, right? The problem with this approach is the tax rate. You pay no tax to invest in your IRA, but what happens if the tax rate goes up later? It might be 10, 20, 30, or even 40 years before you retire. A lot can happen during that time! If the tax rate is lower while you're working, you'd be better off paying tax now and reaping the benefits later.
How Permanent Life Insurance Works
Now, let's look at an alternative way to fund your retirement: with permanent life insurance. The main reason to buy life insurance has always been the death benefit. If something happens to you, your family (or other beneficiary) receives the cash they need to pay bills. However, permanent life insurance also builds cash value that you can pull out, potentially tax-free, to pay for retirement.
How does it work? In most situations, you can withdraw or take loans against your policy's cash value absolutely tax-free (up to the value of premium payments you've already made). No, it's not a magic solution—the more you pull from your cash value, the less may be available for a death benefit if you pass away. It's a trade-off that doesn't work for everyone. However, chances are the older you get, the less death benefit you'll need anyway. The kids are probably grown and you might have already paid off the mortgage. If your financial commitments are shrinking, it could be a smart solution to pull money from your policy to support your retirement...without worrying about a growing tax rate that shrinks the value of your dollars.
Give me a call or send me an email to get your retirement back on track with permanent life insurance!
Statistic source: "3 reasons IRAs have edge over 401(k)s when it's time to tap your nest egg," USA Today.