A. Yes, for people who are looking to leave a legacy to their heirs, Roth IRA and Life Insurance are two of many options. Life Insurance and Roth IRAs have a basic structure in common - they are both wealth transfer tools that help facilitate an efficient transfer of assets from one generation to the next; and they both can provide a tax-free legacy.
Despite their many similarities, Roth IRAs and life insurance are very different, and the rules that apply to one don’t always apply to the other. In fact, more often than not, that’s the case. Below, we discuss 3 of the biggest differences between the two vehicles.
#1: Roth IRAs are always included in your estate
Thanks to the 2015 $5.43 million federal exemption amount — the amount that can pass estate tax free to beneficiaries — estate tax concerns are nowhere near what they used to be. Most people will not owe federal estate tax when they die.
Yet, a small segment of the population has to contend with such concerns. Plus a number of states still impose state estate taxes; and many of those states have set their exemption amounts much lower than the one available at the federal level. In such cases, life insurance may offer an advantage over Roth IRAs.
The “I” in IRA stands for individual, meaning it’s always a person's asset; and, therefore, the value of the Roth IRA is always included in that person's estate. If you are above the federal estate tax exemption amount or your applicable state estate tax exemption amount, your beneficiaries could end up owing estate tax — at the federal level, state level, or both — on what they thought were “tax-free” Roth IRA assets.
Life insurance, in contrast, can be structured so that it’s outside of a person's' estates, producing not only an income tax-free benefit to their heirs, but also one that is not subject to estate tax, regardless of the value of their estate when they die. In other words, it is a truly tax-free benefit.
There are a variety of ways to accomplish this, including having an irrevocable trust (or, alternatively, let your children or other interested parties) purchase the life insurance policy. To figure out which option is best, consider bringing an estate planning attorney into the mix.
In our next blog post, we will discuss the second difference between Roth IRA and Life Insurance – contribution limits.