TFRA: The Tax-Free Retirement Account That Helps Minimize Taxes on Retirement Income
A tax-free retirement account, or TFRA, is a type of cash value life insurance plan that’s created to help eliminate taxes on your retirement income.
In this post, we’ll take you through what a tax-free retirement account is and how they differ from traditional 401(k) plans and Roth IRA, as well as any current federal or state tax advantages or disadvantages in the near future that may change the viability of this from a retirement savings strategy. Let’s get started!
What is a TFRA?
A TFRA is a tax-free retirement account. It is NOT a qualified retirement plan or an employer-sponsored retirement plan. These individually owned plans build up cash value and allow you to access the cash as income on a tax free based due to the internal revenue code.
They have many advantages compared to a 401K and Traditional IRA. Mostly the fact that you can not lose money and they are not directly invested in the market.
How Tax-Free Retirement Accounts Work
A TFRA account is a retirement investment plan that works similarly to a Roth IRA but offers some important differences. A TFRA allows you to invest money with after-tax dollars and the investment gains, income, and death benefits are all tax-free.
This is the only type of retirement plan that has that triple tax advantage.
- Tax-free gains
- Tax-free income
- Tax-free transfer of wealth upon death.
These plans are also referred to as a LIRP or 7702 plan.
When do you start investing in TFRAs?
Because TFRAs are intended for long-term investments, you should be investing in them as early as possible. Many young people might have an easier time getting approved for a TFRA than an older unhealthy individual; even if you can only a lower dollar amount now, you can contribute year after year and let your investments grow. TFRAs also provide special tax advantages over money in their 401(k) or other retirement accounts.
Who can invest in TFRAs?
A TFRA is essentially an investment account that has some unique characteristics. Unlike a traditional 401(k) or Roth IRA, which requires you to be at least 18 years old, there are no age restrictions when it comes to setting up a TFRA account.
And unlike other retirement accounts, such as a 401(k), where withdrawals prior to age 59 1⁄2 typically incur an early withdrawal penalty, there are no penalties for withdrawing funds from your TFRA before age 59 1⁄2.
To set these tax free retirement plans up, you must have an illustration first. Which we can provide by simply completing our quote form in the side bar.
Tax-free retirement accounts are one of the few that are completely tax-free and has no annual contribution limits or income restrictions.
TFRA vs 401k
A 401k is an employer-sponsored retirement account. These plans are qualified plans and they may grow tax-free because they are funded with pre-tax dollars, but that just means you will pay taxes when you take the money out. Meaning you delay tax implications to the future.
A 401k ties your money up until at least 59 1/2 or you will pay a penalty for accessing the money, there are some exceptions to these rules for 401k plans and other qualified plans.
The biggest difference between a tax-free retirement account and a 401k is that contributions to a TFRA are made with after-tax dollars, while contributions to a 401k are made with pre-tax dollars. This means that if you contribute $5,000 to your TFRA account, you’ll have $5,000 less in taxable income for that year.
Your employer typically matches some portions of your contribution limits if they offer a 401k. We recommend investing in your 401k up to your employer’s match because why would you pass up free money. It can be easily set up with automatic payroll deduction through your employer.
After the match, there are so many reasons to invest your money in tax-free retirement accounts over your 401k. Downside risk protection and not owing future taxes on your retirement income are the biggest reason.
TFRA Account vs Roth IRAs
Your TFRA account is a retirement investment plan that works similarly to a Roth IRA with some of the same rules but offers some important differences.
A Roth IRA account offers several tax benefits and tax savings, but only to those who are eligible. On top of that, a Roth IRA account also limits your contribution. To have more flexibility and to further minimize income taxes and taxes upon death, you may want to consider opening a TFRA retirement account instead.
Both types of retirement accounts will help ensure you are saving for retirement, but a TFRA account offers several additional perks. Like a death benefit if you die young.
Another big advantage of a Roth vs a TFRA is you do not have to wait until 59 1/2 to get your money out of the account. Once you have enough cash built up you can access the money anytime via loan or withdrawing money.
Advantages of a TFRA
In addition to minimizing taxes during retirement, a tax-free retirement account can be opened at any age and allows you to save money over time in a tax-deferred manner.
They also have the triple tax advantage that no other retirement account can offer.
- Tax-free growth on all gains
- Tax-free income in retirement
- Tax-free transfer of wealth upon death
Some other advantages are you have no stock market risk. You can not lose the money invested in these accounts like you can in a Roth IRA or 401k.
Disadvantages of a TFRA
These types of plans also come with a death benefit so you will need to medically qualify with the life insurance company before you can purchase. If you have had major health issues you may not qualify.
Also if you are currently in a higher tax bracket you do not get a tax deduction on your contribution limit because the premiums are paid with after-tax money.
What are some other considerations?
If you’re looking for a tax-free strategy for long-term financial planning, you may want to explore a tax-free retirement account. Alternatively, you can also use 401(k)s or IRAs to save money for retirement on a tax-advantaged basis.
One of the best ways to make sure you have a comfortable retirement is to generate more streams of income. This can be done through 401k, a TFRA, an annuity, or a ROTH IRA.
Also, while most people don’t start thinking about their retirement until they hit their 40s or 50s, experts suggest starting as early as possible and putting away as much as you can afford—no matter how small—in order to take advantage of compound interest over time.
How to Open a Tax-Free Retirement Account
There are a few requirements that must be met in order to open a TFRA, but don’t worry—they’re not all that complicated.
We will take these steps before trying to open an account:
- Complete our questionnaire so we can determine goals
- We design and send over a compliant illustration showing income
- We get on a Zoom call to review the plan and answer all questions
- We submit the application to the carrier for approval
- We get an approval back, sign and submit premium payment
We need to determine what your current tax liability in retirement might be, based on the income your existing retirement plans are going to generate. Also, we need to know how much income could be created using a tax-free retirement account. All this will be shown in the illustration we send you.
A TRFA or tax-free retirement savings account is a great option for those who want downside market protection, uncapped upside reward, and who want to leave their wealth to the next generation all tax-free.
Interested in getting a TFRA as part of your retirement planning strategy? Contact one of our Insurance Geeks to discuss possibilities. Plans like these do have some guidelines they must follow under Section 7702 so it isn’t a project you can undertake on your own.
We are experts at designing and maximizing these plans for our clients.