Indexed Universal Life Insurance (IUL) vs. 401K: Which is Better for Retirement Savings?

Thang Truong
Thang Truong
Updated on:

If you are looking for ways to provide for yourself in retirement and maybe even leave something behind for loved ones, there are plenty of financial products on the market. In fact, some of them are quite similar, such as an indexed universal life insurance (or IUL) vs. 401k. 

Depending on your financial position in life, you may want to focus on one type of product over another or invest in both of these options.

What is a 401k? And Its Benefits?

A 401k is a tax-advantaged retirement plan that many people open to begin saving money for their retirement. These plans allow money contributed to them to grow tax-deferred. Only the withdrawals from your 401k are taxed, which can provide a big boost to the growth rate of your retirement savings. 

Many 401k plans are provided through employers for their workers. Employers will also match contributions that workers make to their funds to increase savings even faster. There are also Individual 401k plans available for freelancers and those who don’t have a 401k set up through their employer.

If you withdraw money from 401k account after 59 1/2 years old, you will have to pay income tax for the capital gain portion. For example, if the total principal of your 401k is $100,000, ie. the money that you and your employer contribute to your 401k account, and over the years, it has increased to $200,000 thanks to the capital gain from the investment. When you withdraw money from the account, you have to pay income tax at your personal tax rate (usually around 30-40%) for the capital gain portion, which is $100,000 in this example.

If you withdraw money from your 401k account before you reach 59 1/2 years old, on top of paying income tax on the capital gain portion, you are also required to pay penalty of 10% on the amount you want to withdraw.

>>MORE: Understanding Indexed Universal Life Insurance – Is It Good for Retirement Planning?

Benefits of a 401k:

  • Tax-Deferred Growth
  • Potential Employer Contributions
  • Flexible Plan Options
  • Easy Contributions through Paychecks
  • Some Control Over Investments
  • Interest Earnings and Compounded Interest Earnings

What is Indexed Universal Life Insurance? And Its Benefits?

An indexed universal life insurance (IUL) policy is a type of permanent life insurance that allows you to tie part or all of the cash-value portion to the performance of an equity index, usually the S&P 500 index. Now, what does that mean? Essentially, you can increase the growth of your IUL’s cash-value faster by basing growth on the stock market.

You don’t have to actually invest in the stock market. The insurance company simply uses the interest-earnings of a chosen index as a tape measure to determine how much your insurance policy’s cash-value will increase in a year. Most IUL policies boast a 0-2% floor, which means that your cash-value doesn’t decrease if the index has a negative year. It just won’t increase in value for that year.

>>MORE: Should I Invest in S&P 500 Index Through an Indexed Universal Life Insurance (IUL) Policy?

The unique strength of indexed universal life insurance, similar to all cash value life insurance products, is that when you withdraw money from the cash value account of a life insurance policy, it is actually tax-free. You don’t pay any tax at all on the money you withdraw. Learn more about life insurance proceeds are not taxable.

When you borrow against the cash value account of your policy, you may have to pay interest rate to life insurance companies. However, it is usually much lower than income tax rate, around 3-6%. It tends to be higher in whole life insurance than in indexed universal life or variable universal life. This feature makes it arguably the best investment products in the market for your retirement planning.

>>MORE: Compare Whole Life Insurance with Indexed Universal Life Insurance

Benefits of a Indexed Universal Life Insurance (IUL)

  • Growth is tied to an equity index meaning potentially high returns
  • No losses in cash-value with a 0% floor
  • You choose the percentage of participation
  • You can also adjust death benefit amounts as needed
  • Enjoy tax-free capital gains on cash-value increases
  • Loans and withdrawals on the cash-value can provide income in retirement
  • And finally, your beneficiaries can still receive death benefits when you pass away

>>MORE: Case Studies of Universal Life Insurance

Differences Between Indexed Universal Life Insurance VS. 401k 

Both indexed universal life insurance and 401K seem to serve as effective financial tools for retirement planning. However, they have differences as we outline in the table below:

401K Account Indexed Universal Life Insurance 
Money invested in the accountPre income tax money; tax-deferred growth Post income tax money; tax-deferral growth 
Match from employers option Yes No 
Convenience Yes. Automatically taken away from paycheck No. You have to buy it separately 
Investment growth, capital gain Yes. Grow as market performs well. Usually tied to mutual funds or ETFsYes. Grow as market performs well. Usually tied to different index funds 
Cap and Floor No Yes. Growth cap at a certain level, usually 9% and floor at 0%. 
Can withdraw to supplement retirement income Yes. No penalty after 59 ½. However, have to pay income tax on capital gain portion (usually 30%+) Have to pay penalty fee if withdraw before 59 ½ Yes. Completely tax-free provided the policy is always in force. No age limit as long as enough reserves have built up in the cash value account of the policy Have to pay interest rate to insurance companies in some cases. (usually 3-6%) 
Limited Contribution Strictly limited contribution based on age. Limited contribution based on policy’s initial death benefit or coverage; but offer flexibility to increase contribution for a larger policy’s value. 
Death benefit to beneficiaries Yes. Whatever left in your 401K can be passed to your beneficiariesYes. Death benefit to beneficiaries might change over time, but IUL often provides a much larger death benefit compared to 401K given the same contribution amount

Let’s take a look at the key features of each financial product!

Features of a 401k

  • Contributions are invested in the stock market, usually mutual funds and exchange traded funds.
  • You choose whether to pay taxes on earnings now or on withdrawals from the 401k later.
  • The 401k doesn’t require premium payments, but there are some annual and event-based fees.
  • You can take out loans against the 401k account.
  • Your employer may make contributions for every dollar you put into the account.
  • You can set a beneficiary for your 401k in the event of your death.
  • The amount given to a beneficiary is what’s left in the 401k minus some fees.

Features of an Indexed Universal Life Insurance Policy

  • Interest earned on the cash-value is tied to the growth of a selected index fund. 
  • You don’t actually invest in the stock market.
  • The cash-value of your insurance policy grows tax-free.
  • All death benefits to your beneficiaries are free of federal taxes.
  • If you stop making premium payments and the interest doesn’t cover them, the policy may lapse.
  • You can take out loans against the IUL and make withdrawals without penalty.
  • There are no employer contributions to your indexed universal life insurance policy.
  • You can also set the beneficiaries of your indexed life insurance policy.
  • The death benefit on a IUL could potentially be larger than the value of your 401k.

Comparing an indexed universal life insurance vs. 401k reveals that the two financial products are quite different in their original intent. Yet, each can be used for additional income in later years. A 401k offers the convenience of continued income in retirement without a premium. However, you may end up paying a modest annual administrative fee. 

An indexed universal life insurance policy will provide regular payments in retirement too, but you’ll need to keep an eye on those premiums to ensure continued coverage. The IUL will also give your beneficiaries a much larger death benefit compared to the simple payout of what remains in a 401k to loved ones when you pass on. 

Ideally, you should contribute the maximum to your 401k to get maximum employer match. After that, if you still want to save more for your retirement, get an indexed universal life insurance policy. Make sure to discuss with a licensed life insurance agent so that he or she can help you compare quotes to get the best one. Here is our recommendation of the 6 best IUL companies for your consideration.

Thang Truong
Thang Truong

Thang Truong covers small business insurance and small business success at BravoPolicy. He is a licensed P&C insurance agent. Previously, he held product leadership positions at, Capital One, NerdWallet, and Mulberry Technology. He holds a MBA degree from UC Berkeley - Haas School of Business.

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