Is IUL a Good Investment Strategy for Retirement?

Thang Truong
Thang Truong
Updated on:

Funding retirement is an age-old question many people wrestle with for decades before they actually retire. How much will be enough? Should I invest all my money in IRA’s or 401(k)’s? What about the stock market? An investment strategy that some people fail to consider is the IUL or Indexed Universal Life Insurance.

What is an IUL?

An indexed universal life insurance or IUL policy is basically a life insurance policy with a cash account attached. However, unlike whole life insurance, the cash account is put into a strategy that mirrors an index account in the stock market, say the S&P 500. This strategy has great appeal to many people because they reap the gains of an upturned market but are protected from losses. With an IUL policy, you’re not actually investing in the stock market, but your return is based on market performance. 

Usually, there are caps and floors associated with the cash account. A cap is the maximum you can earn, and a floor is the least. So, if you have an account with a cap of 12% and a floor of 1%, the most you can earn in a given year is 12%, even if the market returns a higher value. On the other hand, a floor of 1% means that if the market loses money, you will earn 1%–a minimal amount, but still better than losing money. 

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

Why is IUL a Good Investment Strategy for Retirement?

There are several solid reasons why investing in an IUL policy is a good strategy for your retirement.

All of these are excellent points to prove that IUL is a good investment for retirement. Let’s examine them one by one.  You should also know that in some scenarios IUL is not a smart investment strategy for retirement.

>>MORE: Understanding Indexed Universal Life Insurance (IUL): Why Is It A Good Option for Retirement Savings?

IUL Provides Financial Security for Loved Ones

First and foremost, IUL is a permanent life insurance policy. When you die at any time, your heirs will get a lump sum payment, tax-free. It also serves as a tax-shelter for high-income folks whose heirs may be met with a huge tax bill on their other investments.

Similar to whole life insurance, it provides permanent financial coverage for your loved ones whenever you pass away. However, it is much cheaper than whole life insurance. For a similar coverage amount, you probably pay less than half of whole life premiums.

>>MORE: Retirement Savings Strategies for High-Income Earners

IUL’s Don’t Have Contribution Limits

Once you start looking into retirement, you will note that the IRS sets limits on how much you can contribute to any retirement accounts such as 401k or IRA or Roth IRA. For 2020, the limit to contribute to an IRA or Roth IRA is $6,000 ($7,000 if you’re over 50). This is your total contribution—to your IRA and your Roth, and $28,500 in an 401K account. An IUL, on the other hand, has no contribution limits. As long as it doesn’t become a Modified Endowment Contract (MEC) you can add as much money as you want.  This makes it ideal for high-income earners who have maxed out their IRA’s and 401(k)’s.

>>MORE: Compare 401K account and IUL Policy: Which one is better for retirement savings?

Withdrawals and Loans From the Cash Value Account in IUL Policies Are Tax-Free

You’ll be supplementing your retirement from the cash value account. Any withdrawal and/or loans that you take from the cash value account of an IUL policy are completely tax-free. If you don’t pay back the loan, it reduces the death benefit, but since your goal was to supplement your retirement, that’s okay. 

If you withdraw from your 401K or IRA account to supplement for your retirement income, your withdrawals will be subject to long-term capital gain tax, which can be from 15-30% depending on your income at the time of withdrawing.

>>MORE: Tax Benefits of Life Insurance: Compare with Other Retirement and Investment Accounts

>>MORE: How Much Income Tax Will You Pay in Retirement? A Case Study

Investing in an IUL Policy is a No-Risk Way to Invest in the Market or S&P500 Index

Sort of. You’re not actually investing in the market or the S&P 500 Index, the insurance company is using the performance of the S&P500 Index to base your earnings on. You are protected from market losses in bad years, and you might earn less than the market does in a particularly high growth year. On average of the past 20 years, the cash value account of an IUL policy with a cap rate of 13.5% and floor rate of 0.75% earns 7.5% annually while the S&P500 index fund earns 4.5% annually.

If you are not financially savvy enough to manage your own investments, IUL policy is a great way to invest your retirement savings without exposing yourself to investment risks. The insurance company will manage everything for you and they have much more experience in managing investment.

Cash value in IUL policy provides a better return on investment than other insurance policies:

The cash value in IUL policies was designed to grow faster than it does in any other type of insurance policy thanks to earning interest rates based on the performance of the market or S&P500 index. This gives you a better return on your investment and a bigger nest egg in retirement. If you don’t need to withdraw from your IUL policy to supplement your retirement income, your beneficiaries will receive a much bigger death benefit when you pass away.

>>MORE: Whole Life Insurance vs. Indexed Universal Life Insurance (IUL): Which is Better?

No minimum distributions nor penalties for early access in an IUL investment account

In a 401(k) or an IRA, you’re required to take minimum distributions starting at age 70 and ½ , unless your 70th birthday is later than July 1, 2019 in which case you can wait until you turn 72. Either way, you can’t leave the money in there forever. On the other hand, you can’t take it without incurring significant penalties until you’re 59 and ½.

The cash value from a IUL policy, on the other hand, has no such age restrictions. You can withdraw money from the cash value account of your IUL policy at any time without any penalties or you can leave all money in the cash account to earn interest rates and pass it on to your beneficiaries when you pass away if you don’t need to withdraw.

>>MORE: Roth IRA vs. IUL: Which one is better for retirement savings?

Income from an IUL policy has no effect on Social Security benefits

Depending on how much money you have, up to 85% of your Social Security benefit is taxable. If you file as an individual and earn more than $34,000 (AIG – Adjusted gross income) 85% of your benefits are taxable. Luckily, the cash value from IUL doesn’t count towards AGI. 

For an illustration of IUL policy for retirement income in action, see our case study

If you are interested in looking for an IUL policy as a part of your retirement plan, consider one of the 6 best companies for IUL product that we recommend.

Pay Attention to IUL Illustrations

Pay attention to the policy illustration. If you bought the policy before 2015, it’s possibly the policy illustration was a little more optimistic that it should have been. No matter what year you bought the policy, pay attention to the gains and losses. You will have to make adjustments  for the policy to work as intended.  It’s also important not to take so many loans that you struggle to pay the premiums and the policy lapses. 

Indexed universal life has also come under fire lately for being difficult to understand. Make sure you know what you’re getting. If you plan accordingly, IUL should work as a retirement supplement strategy. Be sure to review your plan every year, so you can adjust the amount you pay in premiums. 

When is IUL not a Good Investment Strategy for Retirement?

Having considered all good points above, in some scenarios, IUL can be a bad investment strategy for retirement. If you don’t ever need financial protection for your loved ones, ie. nobody is dependent on you financially, you shouldn’t consider IUL or any life insurance product for that matter. All other benefits of an IUL policy are great, but they come with fees and insurance costs to keep your IUL policy in force. This is all worth it if you need financial protection from the policy for your loved ones when you pass away. But if you don’t need that, the fees and costs you have to pay to have the insurance coverage aren’t worth it.

If nobody is dependent on you financially, you will be better off investing in your 401K, IRA or Roth IRA account, or an investment brokerage account for retirement.

Last Thoughts

If you’re looking for a way to supplement your retirement income tax-free and have permanent life insurance coverage, consider IUL. The cash value combined with your Social Security benefits should see you into a comfortable retirement. 

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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