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Is IUL Good for Retirement?

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Indexed universal life insurance (or IUL) can be good for retirement because it protects your savings from stock market crashes. It also has the potential to earn more than a whole life insurance policy. IUL is able to accomplish this slightly higher return potential because it uses index accounts that are linked to the movement of a market index.

But the real power of the product is the protection comes from the fact that your index account can never return less than 0%. In other words, your index account(s) will never have a negative period due to a market crash. Having a portion of your retirement savings in an asset that eliminates the sequence of returns risk is the most powerful weapon you have against running out of money in retirement.

Is Indexed Universal Life Insurance Good for Retirement?

It is a cash value life insurance product that pays an interest rate based on the return of a particular index over a period (typically one year).  The insurance company determines the interest rate each year based on the movement in an index (usually a stock or bond index).

This provides the opportunity for substantially higher interest paid on the cash versus traditional fixed-interest insurance products while also protecting the policyholder’s cash from loss during bad economic times.

One of the areas where indexed universal life insurance shines brightest is retirement planning.  The ability to earn well-above-average interest on a fixed-interest savings plan coupled with the unique features of life insurance policy loans–especially indexed style loans–puts IUL in a strong position to help you in your pursuit of building reliable retirement income streams.

The product produces respectable returns with far less volatility than traditional stock market investing.  And IUL, just like all cash value life insurance, insulates you from principal risk in times of rising interest rates, which is a major concern for bond investors right now.

The lack of volatility in year-over-year returns puts indexed universal life insurance in a position to generally produce more dollars in income per amount saved/accumulated in retirement.  In other words, you can do more to create retirement income with IUL with fewer total dollars achieved by retirement than you can with traditional investments.

Better than a 401(k)?

One is not better than the other.  They both provide unique benefits that will be more or less attractive to an individual based on specific needs.  The 401(k) is certainly more widely available to average employees through their employers.  For these people, a large percentage of the U.S. population, starting a 401(k) will likely be easier than purchasing an indexed UL policy due to auto-enrollment.

So long as you understand the tax consequences of your 401(k) savings, there is nothing wrong with opting for this route due to its ease of access.

I don’t think asking if an indexed universal life insurance policy is better than a 401(k) is the right question.  Most people asking this question do so because they have limited resources to earmark for retirement and they feel they can only choose one or the other.  If this is your situation, you probably need to take a much harder look at your current financial plan to determine where you can come up with additional resources to save for your future.

The IUL will involve more effort to rout out the correct option for your needs, but it will also come with an array of tax benefits that you might find beneficial.

Is it a Good Investment?

While we don’t generally use the term “investment” due to regulatory implications of the term, people often ask this question so it’s important to address it.  Indexed universal life insurance will most likely produce a nominal return on the premiums you pay of around 5% over a period of 20 or more years.  Some products may achieve a return far higher depending on the indexing features available.

Given the tax-favorable features of cash value life insurance, the effective rate of return will be higher when compared to common taxable investment/savings plans alternatively available (e.g. 401(k), traditional IRA, 403(b), etc).  Depending on where your income falls at retirement, this could augment your effective rate of return on an IUL policy by a few percentage points.

In other words, that 5% nominal return could turn into a 7% effective rate of return after taxes.

We recently reviewed an indexed universal life insurance policy we sold over eight years ago and determined that the average indexing credit on the policy was 7.54% since inception, and 6.21% during the past two years.  This puts the policy on track to achieve the nominal rate of return mentioned above.

Can You Lose Money?

You cannot lose money due to a market decline, but you can effectively lose money in an indexed universal life policy if the policy pays zero interest in a given policy year.

This is the case because IUL has ongoing insurance expenses that will come out of the policy’s cash value.  If the index the policy follows is down for the year–potentially resulting in no interest paid on the cash value–then the fees deducted from the policy would theoretically result in a small net loss for the year.  In truth, this isn’t all that common.

We manage dozens of these policies and I can’t identify a year where a policyholder ended up having this happen.  It is possible, just not a very common occurrence and not something that has a strong likelihood of resulting in sustained long-term losses.

This said, there are people who buy indexed universal life insurance and walk away from the policy at a loss.

This happens because the policy will almost never have a positive return on cash value within the first several years.  Additionally, these policies–much like just about all universal life policies–have surrender charges.  So if you are going to commit to IUL, you do so understanding it’s a long-term commitment, or else you very likely could end up losing money.

 

 

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