As of 2013, Roth individual retirement arrangements and variable life insurance policies are the only two ways you can invest in the stock market and not owe income tax on your gains. While these two account types share the same tax benefit, they are structured quite differently. Keep these differences in mind when choosing the best investment plan for your money.
For the same portfolio of stocks, the Roth IRA has a better rate of return than variable life insurance, because a part of your gains in life insurance go toward paying for your life insurance premiums. The Roth IRA doesn't have this extra expense because it is only an investment account. As a result, the Roth IRA is a better option if you're only concerned about getting the highest possible investment return.
The Internal Revenue Service has a couple of investment restrictions on the Roth IRA. As of 2013, you can only invest up to $5,500 a year into the Roth IRA if you are younger than 50 and up to $6,500 a year if you are 50 and older. You can't invest any money in the Roth IRA if you are single and make more than $127,000 or married and make more than $188,000. No such restrictions apply to variable life insurance, making it an option for investors who can't use the Roth IRA.
Variable life insurance is a life insurance policy combined with an investment account. This is both an advantage and disadvantage. If you need life insurance protection, it's convenient to get this coverage through your investment account. If you don't need life insurance, this represents an extra fee that cuts into your investment earnings. In addition, you need to qualify medically for life insurance to buy variable life insurance, and this could disqualify some investors. Because the Roth IRA is just an investment account, it doesn't have any of the benefits or disadvantages of life insurance.
The Roth IRA is more restrictive than variable life insurance when it comes to withdrawals. You can only take your gains out tax free from the Roth IRA if you are 59 1/2 or older. If you take out money before then, you'll owe income tax plus a 10 percent penalty on your gains. The penalty is waived in some circumstances, including withdrawals made for a disability or excess medical bills, but these withdrawals still are taxed as income. With variable life insurance, you can take out your gains tax free whenever you want with a policy loan; no minimum age requirement applies.
Dylan Armstrong specializes in insurance, investing and retirement planning. He has also worked as a life and health insurance salesman and holds a Bachelor of Science in finance from Boston College.