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Yes, Roths Are Tax-Free Retirement Accounts. But TFRAs Refer to Something Else.


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Have a question about saving for retirement or your personal financial situation? Whatever the question, Barron’s Retirement can try to help. Email, and we might look to financial pros for answers.


Q: I’ve been hearing a lot about tax-free retirement accounts and how they’re better than a traditional 401(k). What is a TFRA, and is it really better than a 401(k)?

Much has been written about Roth 401(k)s and Roth individual retirement accounts, which provide savers with tax-free income in retirement because they’re funded with after-tax contributions. But they’re not what people mean when referring to a TFRA.

Instead, says Chuck Czajka, founder of financial-planning firm Macro Money Concepts, TFRA usually references a whole life insurance policy or an indexed universal life insurance policy. Both are permanent cash-value policies that offer tax benefits and risk protection to investors, he says. These policies are sometimes called Section 7702 plans because they’re covered by that section of the Internal Revenue Code.

When you pay premiums on a whole life policy, a portion goes into a tax-deferred component similar to a savings account that earns a fixed interest rate over time. With an indexed universal policy, the cash-value portion earns interest based on the performance of a particular stock market index, such as the S&P 500.

During a market downturn, policyholders won’t lose money, but in exchange for principal protection, gains typically are capped, so investors may earn less over time. In addition, administrative costs can make these policies an expensive way to invest.

“It takes the risk off the table and transfers it to the insurance company,” Czajka says. “The insurance company then invests the money, and you share in the growth with no downside risk.”

Permanent life insurance policies allow you to borrow against their cash value without making withdrawals and paying taxes on that money. If you don’t pay the loan back, that will decrease the death benefit your heirs will receive. Unlike a 401(k) or IRA, these policies don’t have contribution limits, and you can access the money before age 59 1/2 without penalty.

As long as money is taken out using the loan provision instead of being withdrawn, the policyholder pays no taxes. Most permanent life insurance policies also have an available rider known as an accelerated death benefit, which allows the policyholder to access the death benefit to pay for long-term care expenses.

Dan Simon, retirement planning advisor at Daniel A. White & Associates, says these policies might be appealing to workers who are maxing out their 401(k) contributions, have a low tolerance for investment risk, and make too much money to qualify for a Roth IRA.

“It might make a lot of sense for someone with a higher income,” he says.

Otherwise, contribute enough to your 401(k) or Roth 401(k) to fully capture any matching contributions from your employer, Simon says. Then, if you can afford to save more, consider a Roth IRA, he says.

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