IUL vs. 401(k): Smart Retirement Choices

In the last decade, two major market crashes have occurred, causing many working professionals to worry about the long-term safety of their investments. While many have access to retirement saving plans like 401(k) plans, the limits on contributions, costly tax implications, and exposure to market risks make 401(k)s less appealing for conservative-minded savers.

Recently, “IUL,” or indexed universal life insurance, has emerged as an alternative to the 401(k). It’s important to note that IUL is not an investment strategy but a type of permanent life insurance. Be cautious of discussions that treat IUL as an investment vehicle, especially compared to a 401(k) plan.

IUL might appeal to retirement savers, including younger professionals, because of its tax-efficient advantages over the 401(k) and other benefits. These advantages include protection from market downturns, greater flexibility with contributions and accessing funds, and improved tax treatment of future income. However, the suitability of any financial product always depends on the individual client’s needs, circumstances, and objectives.

Here’s a brief overview of indexed universal life insurance and how it differs from a 401(k) as a wealth-accumulating option.

IUL Basics

Like other permanent life insurance products, indexed universal life insurance includes a savings component, also known as an investment component, and offers a cash benefit accessible for various needs.

Unlike other permanent life insurance options, IUL’s interest-earning potential differentiates it. It allows for potential savings growth while protecting your funds during market downturns:

• The account of a policyholder links not to bond funds but to stock indices like the S&P 500.
• Interest credits to the account based on the index’s performance. A rise in the index leads to an increase in your cash balance proportionate to that gain.
• Insurers use a formula to decide how much interest your cash balance earns. If the index rises by 12%, your cash balance might only grow by 6-9% due to this formula.
• Often, there is also a cap on how much interest can credit. For example, if the S&P 500 has an exceptional year and rises by 15%, your cash balance will increase but only up to a set cap.

This structure provides a safeguard against significant losses if the index plummets, ensuring no loss of funds from negative index changes. Some IUL policies even offer a “protection floor” that guarantees a minimum interest credit during market lows.

The growth potential with market protection highlights one of the key differences between IUL and 401(k) plans, which are entirely vulnerable to market downturns.

Unlike with traditional 401(k)s, IUL is funded with non-qualified money, or after-tax dollars. So what you pay into IUL has been taxed already. That’s good news for future income – potentially tax-free retirement income! IUL also offers the advantage of a tax-efficient death benefit for loved ones. And what are some other differences?

401(k) vs. IUL Differences

The distinction between IUL and 401(k) plans largely depends on the specific type of 401(k) plan you have. Here are some of the differences:

• IUL and 401(k) plans fall under different sections of the IRS tax code; life insurance under Section 7702 and 401(k) plans under Section 401(k).
• IUL is funded with after-tax dollars, so contributions have already been taxed, which is beneficial for potentially tax-free future income.
• IUL offers a tax-efficient death benefit for loved ones.

Additionally, 401(k)s may provide an employer match, which IUL policies do not offer. 401(k) funds are susceptible to market losses, lack the borrowing flexibility of IUL, and early withdrawals incur penalties and taxes. In contrast, IUL allows more flexible contributions and tax-free loans against the policy.

For 2024, the contribution limit for a 401(k) was set at $23,000. IUL policies provide contractual guarantees that can preserve your earning power throughout your working years and offer customization options like riders for chronic illness or disability.

While IUL has its downsides, such as potentially high fees and the need for long-term commitment, it might not suit those nearing retirement. It’s essential to work with a knowledgeable, unbiased advisor when evaluating the suitability of IUL or other insurance solutions.

Need Help with Your Planning?

If you’re looking for the right IUL policy or another guaranteed insurance strategy, SafeMoney.com can help. Connect with a financial professional who understands these options and how they fit into a comprehensive retirement planning strategy. Visit our “Find a Licensed Advisor” section to arrange a personal strategy session, and call us at 877.476.9723 with any questions.