What is a Rich Man’s Roth and How is it Useful?
There are a lot of retirement planning tools available to moderate-wage earners, but for the wealthy, maximums and restrictions tend to limit retirement fund options. A Roth IRA is one of these restricted tools. However, even the wealthy need to adequately plan for retirement and set their assets up for strategic growth.
If you earn too much to utilize a tax-free income account like a Roth IRA in retirement, there may be another option: The Rich Man’s Roth.
What is the Rich Man’s Roth?
A Roth IRA is a great way to produce tax-free income in retirement, allowing you to contribute already taxed funds to an account that will compound over time and withdraw the funds later tax-free. Unfortunately, Roth IRAs have a maximum contribution limit of only a few thousand dollars per year. And, if you earn a very high amount each year (over $100,000), you won’t be able to contribute to one at all. This is where the Rich Man’s Roth comes in.
The “Rich Man’s Roth,” or “Rich Person’s Roth” is an alternative to a Roth IRA. It is potentially useful for generating tax-free income during retirement if you make too much money to use a Roth IRA.
A Rich Man’s Roth utilizes a permanent cash value life insurance policy to accumulate tax-free funds over time and allow tax-free withdrawal later. This strategy is best for high earners who can’t utilize a Roth IRA or for those who are maxing out their other retirement accounts and want to save even more to maintain a particular standard of living in retirement.
The Rich Man’s Roth has numerous benefits, including a reduced risk of taxes increasing over time and having to pay more later. Additionally, there are no contribution limits. Overall, this strategy has great potential for high earners.
How it works
To utilize a Rich Man’s Roth, you’ll need to purchase a permanent life insurance policy that offers a cash value savings component. You’ll pay a premium for the policy, part of which covers the cost of insurance, and part of which goes toward a cash value account that accumulates interest and grows over time.
If you die before using your cash value, the insurance company pays out your death benefit but absorbs your cash value. This means that you should be using your accumulated cash value while you’re alive, so you don’t miss out on the funds. Usually, you can withdraw or borrow this cash value tax-free up to the amount of premiums you have paid into the policy.
There are three major ways to use money from the policy. First, you can take cash value out in a withdrawal, the amount and frequency of which will depend on the policy. Second, you can use the funds to pay your insurance premiums.
Third, and most common for this strategy, you can take a loan out against your death benefit. The insurance company may charge a small percentage for interest, but if you make sure you get a policy with a zero net loan, or one as close to it as possible, the interest you accumulate by taking out loans can be canceled out by the gains from investment.
The best way to utilize this type of tax-free income strategy is to give your policy around 10 or 15 years to grow before dipping into it.
Of course, the Rich Man’s Roth doesn’t come without drawbacks. Most importantly, your contributions aren’t tax-deductible. Additionally, if you have poor health, your premiums will be higher, and this plan may not be as useful for you.
To determine whether the Rich Man’s Roth is a good strategy for you to use as you plan for retirement, consult an experienced financial advisor in Los Angeles. Life insurance policies and utilizing them for tax-free income can vary greatly based on the individual and their financial portfolio as a whole, so you don’t want to jump into this strategy without considering all of your options beforehand. And, make sure you work with a Certified Financial Planner™ and fiduciary, so you know you’re getting expert opinions from someone who aims to serve you best.