We all know the advantages offered by Roth IRAs: the potential for tax-free withdrawals and no required minimum distributions have turned the Roth IRA into a powerful retirement income-planning tool. Unfortunately, the rules governing Roth IRAs can make contributing to them—and withdrawing from them—a more complicated and difficult process than is initially apparent, sending many clients on the hunt for additional sources of tax-free retirement income. Enter cash value life insurance, an old planning tool that is experiencing a surge in popularity among clients seeking to maximize their tax-free income during retirement years.
Cash value life insurance comes without these limitations, though the client will have to wait until the cash value in the policy builds up before taking tax-free withdrawals. This process can usually take 10 to 15 years, but a Roth IRA also requires a five-year waiting period before fully tax-free withdrawals are permitted. Once a substantial cash value has accumulated, clients are free to begin making tax-free withdrawals from the policy even if they have not yet reached age 59½. These withdrawals do not have to be repaid into the policy but simply reduce the policy death benefit.
Clients have the option of purchasing a high value policy; in fact, a client who plans to use cash value life insurance for retirement income planning should plan on keeping the policy well-funded because it is important that the policy remain in force until the client’s death. Allowing the policy to lapse can actually leave the client with a large tax bill, so the client should be advised that this is a long-term planning strategy with potentially significant penalties if the policy is surrendered or lapses.
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