What Is Better, a Roth IRA or a Universal Life Policy?

Roth IRA and Universal Life both offer tax-free investing for retirement.

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The Roth IRA and Universal Life Policy are both investment vehicles that can be used to build retirement savings tax-free. The key differences between them make each more attractive for people with differing needs. Determining which is better for you depends on your personal situation.

Roth IRAs

The Roth IRA was created to offer retirement savings free of Federal income taxes. Unlike a regular IRA, there is no income tax deduction for contributions to a Roth IRA. A Roth account gives investors control over the investment choices based on personal goals and risk tolerance. There are no minimum required distributions at any age during the life of account owner. The downsides are limitations on how much can be saved each year and who can participate. For 2013, the maximum that can be contributed to a Roth IRA is $5,500, or, for those over 50, $6,500. There is an annual adjusted gross income -- AGI -- amount that stipulates who can participate. To add the full contribution in 2013, married couples can't have an AGI exceeding $178,000, and single people cannot earn more than $112,000. The maximum income levels to contribute any money are $188,000 for couples and $127,000 for singles.

Universal Life Policies

Universal Life -- UL -- policies were created to offer life insurance protection along with tax-free savings. In the past, life insurance policies that offered savings options didn’t accumulate much savings, but the newer UL products offer numerous investment options through mutual funds and indexed funds. Caps on results options ensure that the value of the account can’t go down, but do limit earnings in a boon year. UL premiums pay for the insurance as well as funding the investments, so overall performance won't match investing the same amount in a Roth IRA, but the added protection is important for many investors. Policyholders can purchase insurance riders that add further value. These include riders that cover long-term care needs or pay the premiums if the policyholder becomes disabled. While there are no income or contribution limits on UL policies, age can make a huge impact on premium costs depending on when you purchase the policy. The biggest impediment for some is the need to pass a health exam to buy life insurance. Someone with poor health might not qualify or may get a more expensive policy that would hurt investment returns.

Differences if You Need Money

Both investment choices allow you to take money out without penalty. The means of doing so differs and restrictions differ. Monies in a Roth IRA cannot be used as collateral for a loan, but a Roth IRA allows accountholders to pull monies contributed without taxes or penalties. The earnings, however, are subject to restrictions on withdrawals. Accessing earnings without federal taxes requires the Roth IRA to be at least five years old. Additionally, the owner needs to reach age 59½, become disabled, or meet other criteria to avoid incurring a 10 percent tax penalty. UL policies offer greater financial flexibility for those who need access to the money. Policies can be cancelled in the initial years, albeit with substantial penalties. Premiums can be missed if there is cash value accumulated to cover them. Additionally, most UL policies allow loans against the cash value. If the loans aren't paid back, the interest and principal will be deducted from the death benefit. There are no age limitations or tax implications on loans. Life insurance contracts also offer the ability to sell or assign the policy to access funds for use by a terminally or chronically ill individual.

What Happens if You Die

A Roth IRA is only an investment account. If you die, your heirs receive only the Roth money you've invested and earned to date, whereas the UL policy offers a considerable death benefit. For example, someone purchasing $1 million in life insurance can leave that much to heirs even if she has paid premiums for only a couple of years. It would take decades of $5,000 to $6,000 Roth investments to equal the death benefit that a life insurance policy offers. Additionally, high-income families sometimes use sizable life insurance contributions as a tax shelter to avoid including the money in the estate.