The IRS strictly prohibits the purchase of life insurance with IRA funds. However, life insurance may be held inside of other types of retirement plans. A life insurance policy gives you many advantages other financial products do not have. Whether the policy is part of your employer's retirement plan or an individual plan, you should understand how this contract benefits you.
A qualified life insurance plan is a life insurance policy purchased inside of a retirement plan such as a 412i plan. These plans normally are managed by your employer with the insurance company acting as the custodian for all the money. A 412i plan must invest in fixed life insurance and annuity policies. The life insurance policy inside the plan is income tax-free, but it is taxable when withdrawn from the plan. The cash value portion of the policy, which functions as a savings element to the policy, is guaranteed to grow at a preset rate. This means your employer may guarantee that you have a minimum amount of retirement income.
Non-qualified life insurance is any life insurance not purchased in a retirement plan. This policy does not have to be a fixed life insurance policy, and it may earn cash value that depends on the performance of mutual funds, current bond interest rates that reset every year or on an equity indexing strategy managed by the insurance company. The policy's cash value is income tax-free as long as the policy stays in force.
You cannot invest in a life insurance policy inside of an IRA. An IRA may invest in many other types of investments, though. IRAs may invest in individual stocks, bonds, mutual funds, real estate and precious metals. IRAs may accept tax-deductible or non-deductible contributions. Traditional IRAs tax all money withdrawn from the plan that has been contributed on a deductible basis. Roth IRAs allow income tax-free withdrawals after age 59 1/2.
Even though you cannot buy life insurance with IRA funds, you can buy an annuity. An annuity is an insurance policy that does not offer an inflated death benefit, as life insurance does. Instead, the death benefit of an annuity equals the current account value of the annuity. Purchasing an annuity inside of a Roth IRA gives you benefits similar to the cash value portion of a permanent life insurance policy, without the cost of insurance associated with life insurance policies.