Retirement plans today consist of many moving pieces. No one should rely only on Social Security – it should be a supplement, not your primary income. But what about a 401K or IUL for retirement?
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Is one better than the other? Should you have both or just one? We discuss your options in the guide below.
Table of Content
- What is an Indexed Universal Life (IUL) Insurance Plan?
- How Does an Indexed Universal Life Policy Work?
- Is Indexed Universal Life Insurance Good for Retirement?
- Indexed Universal Life Insurance Pros and Cons
- IUL vs. 401K, are they Interchangeable?
- What are the Differences between Index Universal Life Insurance vs 401K?
What is an Indexed Universal Life (IUL) Insurance Plan?
Indexed Universal Life Insurance is a permanent life insurance policy, similar to a whole life insurance policy. Your premiums consist of the death benefit premium and money to invest in your cash balance.
As long as you pay your premiums, an IUL policy lasts for your lifetime and offers a death benefit for your loved ones.
How Does an Indexed Universal Life Policy Work?
This policy offers a cash value, much like a whole life policy but without the risk of a losing market. That’s the benefit most people focus on when choosing this policy.
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It differs from a whole life policy because most IULs have minimum and maximum returns. Your money isn’t invested in the stock market but instead follows a specific index. For example, if an index has an annual return of 4%, you earn 4% interest on your cash value.
But there’s a catch.
IUL policies have both a minimum and maximum return. The minimum return may be 0% – it varies by the insurance company. Basically, it protects you against a total loss, unlike a 401K plan. When comparing IUL vs. 401K, this is one area many people focus. It’s scary to think you could lose your entire retirement plan in the blink of an eye, but with an IUL, that won’t happen.
The maximum returns may hurt, though.
Let’s say an insurance company maximizes your earnings at 5%. If the market takes off and has a return of 10% that year, you’d only earn 5% – it’s a tradeoff for the protection.
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Is Indexed Universal Life Insurance Good for Retirement?
The protection the IUL offers makes people wonder – is an Indexed Universal Life Insurance plan good for retirement?
While there’s no one-size-fits-all answer, it does fit nicely into most retirement plans. Should it be your only plan?
You shouldn’t put all your eggs in one basket with any investment. Diversifciation is important. When you diversify, you offset the risk of a total loss, increasing your chance of a higher retirement balance.
If you’ve maxed out your 401K and/or IRA, then using Universal Life Insurance for retirement income may be a great option. If nothing else, it can be a ‘backup’ should you come up short in your 401K or IRA. You can withdraw funds from your cash value or take a loan. Just know that any money you don’t repay gets deducted from your policy’s death benefit when you die (your beneficiaries earn less money).
Indexed Universal Life Insurance Pros and Cons
Like any life insurance policy or retirement plan, the IUL insurance policy has pros and cons.
|You get protection from a total loss, meaning you won’t lose your principal even if the market doesn’t perform well and you don’t earn interest||Your account growth is restricted based on the cap the insurance company sets|
|You can withdraw funds from your cash value tax-free as long as they don’t total more than the premiums you’ve paid||IUL policies have high costs that the insurance company takes from your premiums which reduces how much you invest|
|You don’t have to repay the funds if you can’t, but your beneficiaries will receive a lower death benefit as a result||You’ll need to monitor your account actively and may need to increase your premium payments during times of little to no returns to keep your cash value up for retirement|
|Your beneficiaries will receive the death benefit tax-free|
|You get the benefit of enjoying the returns of a specific index without the risk of losing anything|
IUL vs. 401K, are they Interchangeable?
Many people think of IUL vs. 401K as interchangeable when they should be used consecutively. You shouldn’t put all your eggs in one basket with any return. There’s no guarantee a 401K will perform, just as there’s no guarantee an IUL will perform.
If you put money in both, you give yourself a better chance of entering retirement with the money you want to be set aside.
All retirement plans consist of many moving pieces. Before you choose between a 401K or IUL, think about what other retirement funds you may have, including:
- Social Security income
- Pension income
- Whole life insurance policies
- Cash savings
Then you can decide how to supplement what you already have coming in by opening your contribution account, whether a 401K, IUL, or both.
What are the Differences between Index Universal Life Insurance vs 401K?
It’s essential to understand the difference between IUL and a 401K.
What is a 401K?
A 401K is a defined contribution plan. You can defer up to $19,500 of your income each year into your 401K. This reduces your taxable income dollar-for-dollar, reducing your tax liability today and setting money aside for retirement.
Your money grows according to the investments you put it in, but there’s no guarantee of significant growth or protection from a loss.
You can withdraw funds when you reach age 59 ½ without penalty, but you’ll pay taxes on any money you withdraw. The hope is that you’re in a lower tax bracket when you retire, so you pay fewer taxes and keep more of your hard-earned money.
Some employers also match your contributions. For example, if your employer matches 3% of your salary dollar-for-dollar and you make $100,000 a year, your employer will contribute $3,000 if you contribute as much.
How a 401K and IUL Differ
Now let’s compare a 401K and IUL.
A 401K doesn’t have premiums. You make voluntary contributions that you can change at any time. You can contribute up to the annual maximum, which today is $19,500 unless you’re over age 50, then you can contribute an extra $6,500.
Your balance can go up or down and change hundreds of times throughout the time you own it. You can change your allocations and/or contributions to match what you can afford or react to the market’s performance.
An IUL has premiums because of the death benefit. You must pay the premiums each month to keep the policy active. Any ‘extra’ money after covering your death benefit and administrative costs goes to your cash account.
Your cash account may accumulate interest based on the performance of the underlying index (for example, the S&P 500). There’s no guarantee of high returns, and your returns may be capped at a specific percentage. Most policies include a stipulation that you won’t have a loss. You may make 0%, but you won’t lose your investment.
You can withdraw cash from your IUL at any time without penalty, but you’ll pay taxes on any earnings exceeding the premium payments. If you don’t pay the money back, you withdraw; it decreases the death benefit that affects your beneficiaries, not your retirement funds.
What’s Better – IUL vs. 401K?
There isn’t a case of IUL vs. 401K but rather investing in multiple retirement accounts to ensure you have the necessary funds when you retire.
Should you have just a 401K or just an IUL?
You should diversify your funds to maximize your returns. An IUL is an excellent ‘safe’ account to keep funds in, especially when the market takes a dive. Money in a 401K or IRA will be lost if the market tanks, and it could take many years to make it back.
Money in an IUL may not grow, but you won’t have a loss. You won’t lose the principal amount you invested. While that may not be enough to cover your retirement expenses, it’s money nonetheless.
The ideal retirement plan has money in both an IUL and 401K or IRA to cover all your bases. Take advantage of your employer contributions in a 401K and the tax deferral both 401Ks and IRAs offer, but give yourself the protection of an IUL too.