Planning for retirement isn’t simple. Many investors and their advisors pore over options, looking for the perfect allocation of stocks, bonds, cash and other assets.
“What few of them are thinking about is the tax location,” says Molly Ward, a certified financial planner with Equitable Advisors in Houston. While many people think health care will be their biggest expense in retirement, taxes will likely cost even more, according to Ward. “It becomes this ticking time bomb,” she says.
Not only can savings withdrawals trigger income or capital gains tax, but they could also increase income to the point where it leads to higher Medicare premiums.
“It’s good to have a tax-free source of income in retirement,” says Brandon Goldstein, financial planner with Prudential in Livingston, New Jersey.
Roth IRAs are a common way to generate tax-free income, but life insurance is another option to consider. Each has its benefits, but financial advisors say one will be the better first choice for many people.
[Read: How to Save in a 401(k) and IRA in the Same Year]
Basics of Roth IRAs
Roth IRAs are retirement savings accounts that are funded with after-tax dollars. Money in the account can be invested, and both the principal and gains can be withdrawn tax-free in retirement.
“The Roth IRA is the best vehicle, in my opinion, that people have to grow their money for retirement,” says Thorn Murphy, wealth advisor with Prime Capital Financial in Columbus, Indiana.
However, there are restrictions. In 2025, the government allows workers younger than 50 to deposit only up to $7,000 in a Roth IRA. Those age 50 and older can contribute up to $8,000. There are also income limits on who can contribute to a Roth IRA. The maximum contribution limits for 2025 are $165,000 for single taxpayers and $246,000 for married couples filing jointly.
If you want tax-free income from a Roth IRA, you’ll have to wait until age 59½. Money pulled from an account earlier than that could be subject to income tax as well as a 10% penalty.
“When you get to age 59½, a Roth IRA has a lot fewer strings attached,” says Brian McGraw, senior wealth advisor with Hightower Wealth Advisors in St. Louis.
Still, there are ways to access money from a Roth IRA early. “Where it’s beneficial is you can pull out your distributions at any time,” Goldstein says.
For instance, if you contribute $7,000 to a Roth IRA and that balance grows to $15,000, you can withdraw $7,000 without tax or penalty. That’s because contributions to a Roth IRA have already been taxed.
[Read: What the Rothification of Retirement Accounts Means for You]
Using Life Insurance for Retirement Security
Life insurance is most commonly thought of as a way to provide cash to loved ones in the event of your death. However, it can serve other purposes in retirement.
“You may be able to access it for long-term care or a chronic illness,” Goldstein says. He adds that buying a life insurance policy to provide an inheritance may also eliminate the need to preserve other assets. “You might feel less guilty about spending your other retirement assets,” he says.
A life insurance policy can also be used as a source of income in retirement. However, that is only possible if you have permanent life insurance with cash value. There are many variations of permanent life insurance policies, but variable universal life is a popular option for generating income.
“I feel a VUL is the most apples-to-apples (product) if you are trying to compare to a Roth IRA,” McGraw says.
These policies allow you to invest in stocks, bonds and other equities, in a similar way to how you would invest with a Roth IRA. Those investments come with risk, and for that reason, not everyone is a fan. Murphy prefers whole life policies that provide solid dividends from multiple companies, noting that if he’s going to be in the stock market, he’d prefer not to do that in an insurance product.
Regardless of the policy, “It’s going to grow tax-deferred or possibly tax-free, depending on how you pull it out,” Goldstein says.
How to Create Income from Life Insurance
Typically, to create retirement income from life insurance, people will take out loans against the policy’s cash value. These loans generally don’t need to be paid back during the policyholder’s lifetime but will be covered by the policy’s death benefit. If any benefit remains after the loan is paid off, the remainder will be distributed to the heirs.
It may sound simple, but there are several key considerations that must be taken into account when using life insurance for retirement income.
“This kind of life insurance is not for everyone,” Ward says. “If you’re in a really low tax bracket, it might not make sense.”
You’ll need to start funding a life insurance policy early to make this strategy work. “It takes time for the cash value to build up,” according to Murphy. Even after 10 years, people may discover that their cash value is only equivalent to what they paid in premiums. “It doesn’t look very attractive because of fees,” Murphy notes.
To get the most income possible out of a policy, you’ll also need to manage the death benefit. “That’s a piece that is often neglected,” according to Ward.
“You basically want to have a lean and mean insurance policy,” McGraw says. VUL policies contain two components: investments and insurance. “You don’t want the cash value growth eaten up by the insurance cost. You should build a policy that has the smallest amount of death benefit (possible).”
At the same time, you don’t want to run afoul of government regulations that dictate parameters for premiums, cash value and death benefits. Failure to follow these requirements could mean that a policy is reclassified as a modified endowment contract, which means its gains could be subject to income tax.
For this reason, Ward recommends that people work with a securities-licensed advisor to ensure a life insurance policy is designed correctly.
[Related:Should You Spend Your Nest Egg or Leave a Legacy?]
Roth IRA vs. Life Insurance: How to Decide
When it comes to which option is better, many advisors recommend that people begin by opening a Roth IRA.
“If the goal of this is retirement income, start with a Roth IRA,” Goldstein advises.
These retirement accounts are relatively straightforward and often come with few fees. Major online brokerages make it easy for people to open, fund and manage their own Roth IRAs.
“The slight advantage of the life insurance strategy is that you don’t need to be 59½ (to tap into the account),” according to McGraw. The downside is that life insurance policies are more expensive to set up and more difficult to maintain. “You do have to do your homework and work with someone who knows how to build an efficient policy,” McGraw says.
High-income earners who aren’t eligible for a Roth IRA or who have maxed out their other retirement savings options are most likely to benefit from a life insurance retirement income strategy. However, others may also find it helpful.
“We don’t see it as a competitor to a Roth,” Ward says. “It can be a complement to a Roth.”
Working with a professional who is well-versed in both options is the ideal way to determine if and how a Roth IRA and life insurance policy can fit into your retirement plan.
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Life Insurance vs. Roth IRA: Which Offers Better Retirement Security? originally appeared on usnews.com
