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Dec15, 2022

Should I Use a Roth IRA or Life Insurance to Provide a Legacy?

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In this episode of the Great Retirement Debate, Ed and Jeffrey discuss whether a Roth IRA or Life Insurance is the best option in order to provide a legacy.

Episode Transcript

[00:00:00] INTRO: Hi, I’m Ed Slott and I’m Jeff Levine. And we’re two guys who just love to talk about retirement and taxes. Look, our mission is simple to educate you the saver so that you can make better decisions because better decisions on the whole lead to better outcomes. And here’s how we’re going to do that each week. Jeff and I will debate the pros and the cons of a particular retirement strategy or topic with the goal of helping you keep more of your hard earned money. Yeah, but we won’t know which side of the debate we’re taking until we flip a. Winner of the coin flip gets to pick which side of the debate they want to argue, and both of us will have to argue in favor of our respective positions, whether we agree with them or not. At the end of each debate, there’s going to be one clear winner. You a more informed saver who can hopefully apply the merits of each side of the debate to your own personal situation, to decide what’s best for you and your family. So here we go. Welcome to the great retirement debate.[00:01:00]

[00:01:01] Jeff Levine: All right. Well, welcome back to the great retirement debate. I’m Jeff Levine, Ed, it is good to be with you yet again, to debate an important retirement related topic.

[00:01:12] Ed Slott: All our issues are important, but this is a fun one too, and important for your beneficiaries.

[00:01:18] Jeff Levine: Ooh, you’ve got me at my interest peak. What is the topic for today?

[00:01:22] Ed Slott: Well, if you’re leaving money to your beneficiaries, your legacy, you might wanna say, which is best Roth IRAs or life insurance. They’re both tax free. So it’s a tough choice.

[00:01:35] Jeff Levine: Yeah. Well, alright. Before we flip the coin, Ed, I, I will just say. That, uh, if you’d like to leave me either life insurance or a Roth IRA, I promise I won’t debate afterwards whether it was the right thing or not. You can just, whichever one, you prefer your heart desires. I will be just, uh, just very happy with

[00:01:52] Ed Slott: all right. Noted.

[00:01:54] Jeff Levine: Perfect. All right. Well, let’s flip a coin, Ed. You want heads or you want tails?

[00:01:58] Ed Slott: Uh, heads.

[00:01:59] Jeff Levine: All right, [00:02:00] here we go. Heads for Ed here we go. One, two. Three. All right, Ed it’s tails so I get to choose. I will, uh, I will give you the side of life insurance and I will argue for using Roth IRAs to provide a legacy.

[00:02:18] Ed Slott: All right. And again, by legacy, we mean the, the amount that goes to your beneficiaries. We’re not talking about the impact to you during your lifetime. I like both of them because I like anything that’s tax free because tax free removes the uncertainty of what future higher tax rates can do to your standard of living in retirement and that includes the beneficiaries look, tax free money is always better because it will never be eroded by current or future taxes. So you keep a hundred percent, you don’t have to share any of it with the government, but I’ll say life insurance is better. Even though personally myself, I have them both Roths and life insurance, because life insurance has the leveraged wealth transfer. [00:03:00] Yes. With Roth IRAs, you could still have the investment returns. It still grows tax free, but it’ll only grow tax free for the beneficiaries for the 10 years after death. Under the secure act. After 10 years, most of your non spouse, beneficiaries, that’s who we’re talking about to your children and grandchildren will have to empty that Roth IRA. Now it will be tax free at that point, but then they would have to invest it and probably taxable vehicles or wherever they’re going to invest it. Whereas the life insurance, uh, can do double duty during your life, but as a death benefit, the big windfall come out tax free income tax free, I should say. And that’s another benefit for life insurance if you have a large estate, life insurance can also be set up outside the estate to be a estate tax free Roth IRAs are income tax free generally to your beneficiaries, but they’re still included in the estate. So they could be tapped if you have a large estate for estate tax as [00:04:00] well. So I like the life insurance. You don’t have to worry about all the rules, all the beneficiaries, which beneficiaries, and they just get this giant fund of money, all tax free income tax free, and maybe estate tax free too.

[00:04:16] Jeff Levine: You know, I think the estate tax argument is, is a really good one there Ed, because you’re right. There’s nothing you could do with a Roth IRA to remove it from the estate. I mean, the I in IRA stands for individuals. So it’s yours, right? You can’t give it away. Can’t move it outside of your estate. But Ed, uh, you know, as we sit here and record today, what’s the estate tax exemption?

[00:04:37] Ed Slott: Huge over 12 million, a person.

[00:04:40] Jeff Levine: Yeah, it’s big. It is. And, and even if we, I know a lot of people say, well, what happens if, if, if you know, the, the law expires, if it expires, we go back down to 6 million, a person and 12 million a couple that still covers the overwhelming majority of, of individuals in this country. So very few [00:05:00] people actually have to worry about the issue of moving. You know, moving something out of their estate now to save on estate taxes later.

[00:05:08] Ed Slott: Well, well, I’ll stop you there. That’s the few, the few people that you’re talking about is people that live in my state where it has state estate tax at a much lower level.

[00:05:19] Jeff Levine: That’s fair and a lot. And there’s still, I think it’s about a third of states today still have state estate tax, so that

[00:05:25] Ed Slott: I think, uh, I’m not sure, but I think Massachusetts only has a 1 million exemption.

[00:05:29] Jeff Levine: I think you’re right actually I think that may be the lowest, uh, in the country, uh, right now. But you, you, so, but I think the estate tax argument where that exists is a really good one. I actually think the income tax argument is not a great argument because of the point that you made for me, uh, If someone dies today and their beneficiaries receive a life insurance policy, the proceeds of a life insurance policy, how much of the proceeds are generally tax free? [00:06:00]

[00:06:00] Ed Slott: A hundred percent!

[00:06:01] Jeff Levine: A hundred percent. If I leave you a Roth IRA, and you’d said, you know, well, you got this 10 year period, and then you’ve gotta take it all out. That’s 10 years of tax free growth, after death. Now there’s no guarantee of what future market returns will be. Your portfolio might look different than somebody else’s, but if we use that classic rule of 72, right, where you could say divide 72 by your return each year, and you can get the, the time period, you can go the other way too. Right? You could say divide it by the time period and figure out what return you’d need. If we take 72 over 10 years, if you can get 7% per year, which is not unheard of in a balanced portfolio over, you know, a long period of time, again, not guaranteed, but if you could do that, you are getting 200% of what was left of your tax free, not a hundred percent, 200% of what was left of your tax free. In other words, it’s not just what you are getting in the Roth today, but it’s what you can get in earnings over the [00:07:00] next 10 years, tax free as well. If those 10 years are really good in the market, it can be a lot of tax free growth, which you don’t get with the Roth IRA. As soon as you get the Roth. Once you go and invest those, excuse me, once you get the life insurance , once you invest that life insurance proceeds it’s, it’s taxable after that it’s taxable and you’re on the hook. Whereas with the Roth IRA, you get this 10 year extra buffer. Imagine what you could do in 10 years of tax free growth, Ed.

[00:07:27] Ed Slott: All right. Let me shoot down that argument. Uh, mathematically and theoretically, you are correct, sir, but in real life, you know that many beneficiaries when they inherit are going to wait 10 years to touch the money.

[00:07:43] Jeff Levine: Uh, maybe your kids and my kids, cuz they will be well educated. And hopefully anyone listening to this podcast will do that as well, if they can afford to, because if you can afford to why touch the tax free money?

[00:07:55] Ed Slott: You know, believe me. I talked about, you know, I’ve been talking about the stretch IRA for 30 [00:08:00] years.

[00:08:00] Jeff Levine: Yep.

[00:08:00] Ed Slott: But do you think a 30 year old would, I don’t know, a 50 year life expectancy. They’re gonna just take it 50 years of wait for 50 years to get the little drops coming out. No today the kids need money for everything. It’s when somebody dies, it’s more like a smash and grab. They’re not gonna wait the 10 years in theory, you are right. If they waited and had other assets, maybe combined with life insurance, see if you had the life insurance for the kids, they could use that money and lay off the Roth for 10 years. That might be a better incentive to do both. Like I said up front, give them some money up front because people, you know, most beneficiaries, even if they don’t think they need the money, when they inherit, they find needs for the money. Oh, I wanna fix my house. Oh, I wanna do this. I always wanted a 65 Corvette. Now’s the time that’s an emergency.

[00:08:53] Jeff Levine: It is an emergency. There’s not that many 65 Corvettes left.

[00:08:57] Ed Slott: I don’t even know anything about cars. I just know that was, [00:09:00] that was a big one. So I I’m saying in theory, you’re right. If they had the ability or the, uh, discipline to lay off the money for 10 years, I don’t think that’s, uh, real life.

[00:09:13] Jeff Levine: That’s fair, but all right, so I’ll pivot. I’ll I’ll I won’t make that argument because mathematically, we said, I’m correct. If we can get people to, to actually do it, we think they’re in a better shape. So I’ll make a different argument. Ed, you travel a lot, like I do to speak, uh, you know, around the country, you go to a lot of cities, right?

[00:09:31] Ed Slott: Yeah.

[00:09:31] Jeff Levine: A lot of big buildings in those cities?

[00:09:33] Ed Slott: Uh, I don’t know where you’re going, but yeah. Yeah. Yeah. Alright.

[00:09:36] Jeff Levine: All right. Have you, have you looked at the names on a lot of those building?

[00:09:39] Ed Slott: Yep.

[00:09:40] Jeff Levine: They have a lot of life insurance company names on them, right.

[00:09:42] Ed Slott: That’s right.

[00:09:43] Jeff Levine: That’s right. You think those are inexpensive buildings?

[00:09:46] Ed Slott: I’m not going there with you.

[00:09:47] Jeff Levine: Oh, it’s listen. At the end of the day, those life insurance companies are incredibly profitable and the reason they’re profitable, so incredibly so is because they’re taking in a lot more than they’re [00:10:00] paying out, which means in aggregate, if we’re all buying life insurance, we are more likely to do worse.

[00:10:06] Ed Slott: No, not going there. Uh, you know, it’s funny you say that because years ago, and I wrote about the

[00:10:11] Jeff Levine: I have to, i’m on this side of the argument, Ed.

[00:10:13] Ed Slott: What’s that?

[00:10:14] Jeff Levine: I have to say that I’m on this side of the argument.

[00:10:16] Ed Slott: All right. I’m not going there years ago. Uh, I had a client, uh, for estate planning. He was a perfect candidate for life insurance and he decided not to do it. And just, if you’re listening here, I don’t sell life insurance. Uh, I’m a tax advisor, a CPA. I don’t sell any product. So I’m, uh, you know, I’m giving you independent objective my opinion on this. Uh, so I had this client and he was a perfect candidate because he had a large IRA and that’s back when the estate exemption was much lower and we wanted to do it for all the right reasons, and he says, nope, I don’t like life insurance companies. And I said why? He said, cause they have big buildings.

[00:10:56] Jeff Levine: yeah, I, I get it.

[00:10:58] Ed Slott: Yeah. So he was thinking to say, don’t [00:11:00] worry about what other people make, look, what it can do for you. For example, I talked about the leveraged wealth transfer to your, to the next generation. Yes. With Roths you can build it up through investing, but uh, many times you can invest a certain amount in a life insurance policy and the payoff can be many multiples of that and all of it, all of that growth going right to the beneficiaries tax free. Plus, I’ll give you another one people that have a large IRA that want to leave maybe a Roth IRA to the beneficiaries. They may wanna use a trust because they’re worried about the kids or grandkids coming into all of that money in a short 10 year window. If you leave a, even a Roth IRA to a trust, you have all these tax rules, uh, the RMDs, uh, at the end of the 10 years, even, and who the beneficiary, a whole bunch of, uh, hoops and hurdles and obstacles to go through tax-wise. Life insurance you can get the plan you want. You can leave a boatload [00:12:00] of life insurance, and if you’re worried, because most people with larger amounts going to kids or grandkids want that post death control. You know, clients have always said to me, I don’t mind leaving it to my kids. I’m worried about the ones they marry. They’re always worried about the kids mishandling the money and all their life savings may go to somebody they net never even met. Life insurance to me is the most flexible asset to leave to a trust where you get the post death control, the leveraged wealth transfer and no taxes. So this way you have everything you want in your plan. If you plan on leaving a lot of money to your beneficiaries. Everybody wants it tax free. Every client I ever had, they may not have said it in 40 years, but they always came down to three things. They always wanted, larger inheritances for their beneficiaries, more control and less tax with the life insurance it checks all the boxes.

[00:12:54] Jeff Levine: Well, that’s fair. , but that’s for those who are, are lucky enough to get there. And I know our topic today [00:13:00] is leaving an asset for legacy, but, you know, there’s that old expression man plans or, or, or, sorry. Yeah, man plans, God laughs right. And, uh, because we don’t know what the future holds and yes, I, I think you’re right about the flexibility that’s offered by life insurance, through the, the use of trusts and to move it outside of an estate and, and all of those things, but what about flexibility during life? Right? What happens if things don’t go well, the Roth IRA can easily be pivoted from, well, I was planning to leave this to my kids or my grandkids, but things didn’t go, you know, I happened to retire at the wrong time and the markets are down and things just didn’t. I hoped, I thought I could leave it to them, but I just, I retired at the wrong time or I had this unexpected healthcare need that just came up. It’s hard to convert that life insurance back to income. And if you do the things you’re talking about and putting in a trust and moving it out of your estate, it may be impossible to use those assets, uh, to use any value in the life insurance, if [00:14:00] there’s even a cash value there for your own personal needs. And so one of the biggest benefits of the Roth IRA relative to life insurance is the flexibility for you. The owner of that in case, you know, we might have the best of intentions to leave assets to our children, our grandchildren, our spouses, etc. but things might come up in the interim, which require the use of those dollars and the Roth provides the flexibility for that.

[00:14:25] Ed Slott: Okay, that those are good points. So let me address those. If you feel you might need to a access, some of that money, first of all, the life insurance, if you have the right type, you could access growing cash value in there, tax free. Yes, it does reduce the death benefit, but who cares about that if you need the money

[00:14:43] Jeff Levine: Agreed.

[00:14:44] Ed Slott: Uh, but also, uh, with the Roth. Yes, you can have use of the money. It’s easy, easier to access. And if you feel you, you may need access, then maybe you shouldn’t put pile everything into the life insurance. I always say the plan I’m [00:15:00] talking about is more for the person that says, you know, I had this large IRA and I had an earmarked for my children and grandchildren, and I did the planning and they were gonna do the stretch IRA for 40 50 years and all of that stuff. And now there’s no stretch IRA for them. Uh, thanks to the secure act. Uh, that might be the person that is perfect for the life insurance plan, cause they’re telling me they probably, they have other assets maybe that that would be a. Uh, an issue to look at, do they have other assets? So if they tell me they have other assets and this money was earmarked, we don’t even need it. In fact, some people tell me we don’t even want it because they don’t, they don’t want RMDs and all of that stuff, they said that was earmarked. So that’s the money. I would say the traditional IRA, take that down at today’s low rates. Maybe over time, use up today’s low brackets. Put that in a life insurance policy, it won’t change your life one bit. That’s the better candidate for the plan I’m talking about.[00:16:00]

[00:16:00] Jeff Levine: Well, if you’re gonna take it down over many years, you could also take it down and do Roth conversions over many years and build up that Roth pile. And there’s one more benefit. I think I, I would be remiss in state and not pointing out with respect to the Roth. And that’s, you know, you are talking about people using life insurance. If they’ve gotten to the point where they know they’re comfortable and they’ve got more than enough, well, that means you’re, you’ve probably reached a certain age, right? Like you’re, you’re at a certain point in your life where, you know, if you, if you’re 40 years out of, of where you think you may die, 40 years, a long time to not be able to, you know, it’s hard to see 40 years into your future. So a lot of people, unless they have just massive amounts of wealth, they won’t feel comfortable in their own retirement yet it may take until they’re 20 years out from where they think they might make it or 10 years out. And by that point, maybe they’re ill. Maybe they’re only starting to think that, oh, I can leave some of this money to my heirs because I’m not going to live that long. And if they don’t think they’re going to live that long, the insurance company [00:17:00] probably won’t think they’re going to live that long. Meaning they may not even be able to get insurance because of their health concerns at that point, there is no, uh, there’s no health requirement for doing Roth conversions. You could do Roth conversions, literally on your deathbed. In fact, Ed, you and I, for years have talked about a strategy called the deathbed Roth conversion. It’s literally meant to be like one of the final things that happens in someone’s lifetime. There’s no issues with making that tax free benefit for your heirs at the last second, but with a life insurance policy, you have to do that well in advance. And to do that, you have to know well in advance that you will have those dollars available and that may be difficult for a lot of people.

[00:17:45] Ed Slott: Right. But if you had the client, that’s a good point. But if you had that person in front of you and you saw the benefits of life insurance, would you tell them to get into that? And this goes back to all planning we talk about, of course you wanna plan before the situation happens. That’s why they [00:18:00] call it planning. Wouldn’t you tell that client to do it earlier rather than later or too late?

[00:18:06] Jeff Levine: Yes. If they were going to do that, I would have them do it sooner rather than later, uh, provided. I knew that they could make it through their retirement, but again, that’s, that’s the unknown, right? We just don’t know what the future will hold. Uh, of, you know, years ago, people thought that they could put their money in the bank and making 5% interest forever would be a no brainer. And then we went for years now where people thought, well, I’ll always be able to get a mortgage at 0% and neither of those things turn out to be true because we just don’t know what the future holds.

[00:18:35] Ed Slott: Right. But the point is that we always come down to this. It seems like in the last few episodes of this, uh, podcast, we come down, it comes down to the same thing. We realize there’s an issue. I happen to like both the Roth and the life insurance, but it comes down to planning the earlier the better, it always comes down to this. The more you plan, the more you keep.

[00:18:57] Jeff Levine: I would agree with that. And you’re right. [00:19:00] We, we do end up coming down to that over and over. So as a quick recap, you know, talking for, for someone thinking like, wow, covered a lot today, what are some of the key takeaways? If we’re looking at life insurance as a potential benefit Ed, I think some of the key insights you provided there are that it could be a defined value, right? You don’t have to worry about what the market does. You can just say, I will pay the insurance company X and my heirs will get Y and whatever things happen in the interim. That’s on the insurance company. Not me. I can know I’ve left behind a legacy. In addition to that, You mentioned the really strong benefit. The fact that it’s tax free to heirs as is Roth IRAs, but also the fact that you can shift it outside of your estate. So for those who believe they will have an estate tax issue today, or maybe don’t trust Congress to keep the current estate tax exemption, where it is that life insurance may provide a value there. Some of the key arguments I made, I think are not only that it’s tax free at the time of your heirs receiving it, but they get an extra 10 years in which to keep those dollars invested, which [00:20:00] could see the amount that they get potentially double, right? Obviously their investment gains and losses are up to them. It depends on what happens, but it could allow that money to double or even more over that 10 years, giving them an even bigger tax free windfall than they would’ve had via life insurance. It provides more flexibility for you, the owner during your lifetime. Should you need those dollars and perhaps, uh, you know, significantly as well, there are no underwriting requirements. You can do it at any time. Would you agree with that, Ed?

[00:20:28] Ed Slott: Well, except for the fact that you’re giving beneficiaries too much credit to keep their hands off their inherited rock funds for a full 10 years.

[00:20:36] Jeff Levine: Get your sticky fingers off your own inheritance. That’s right. Well, one thing that they do share in common Ed is that they’re both tax free and we both agree that, uh, tax free sounds pretty good. Right?

[00:20:47] Ed Slott: Right. Tax free is always better. It’s my number one, always rule.

[00:20:52] Jeff Levine: All right. Well, Ed, there are two sides to every coin in every debate, but your life and retirement decisions [00:21:00] are too important to leave up to that coin flip and that’s why one thing that you and I always continue to agree on is that people need to make sure they’re thinking through any big decision like this with a knowledgeable financial advisor or tax professional so that they can weigh the pros and the cons of the different options against their specific set of goals and objectives. Look, if you’d like to continue the discussion with Ed or I, we’d love to hear from you. Tell us what we missed. Tell us the points that you thought were the best. You got a topic for a future debate. We’d love to hear from you. Let us know you can reach Ed on Twitter at @TheSlottReport, that’s @TheSlottReport with two Ts. You can reach me @CPAPlanner. That’s @CPAPlanner. We’d love to hear from you Ed, as always. It’s been a pleasure. I look forward to our next debate.

[00:21:49] Ed Slott: Yep. Our next installment on the great retirement debate!

[00:21:52] OUTRO: Jeffrey Levine is chief planning officer for Buckingham wealth partners. This podcast is for informational and educational purposes only, and should not be [00:22:00] construed as specific investment accounting, legal or tax advice. Certain information mentioned may be based on third party information, which may become outdated or otherwise superseded without notice. Third party information is deemed to be reliable, but it’s accuracy and completeness cannot be guaranteed. The topic discussed in corresponding arguments are those of the speakers and may not accurately reflect those of Buckingham wealth.