Many options are available when planning for retirement. Two popular options are life insurance retirement plans (LIRPs) and indexed universal life (IUL) insurance. Both offer a blend of life insurance coverage with opportunities for cash value growth. However, they operate differently in terms of structure, flexibility and investment potential. Understanding the key differences between a LIRP and IUL can help you plan for your financial future so you can enjoy a smoother retirement.
If you want to add life insurance to your retirement plan, a financial advisor could help you compare the benefits and drawbacks of different options.
What Is a LIRP?
A life insurance retirement plan combines life insurance with retirement savings benefits. It’s essentially a permanent life insurance policy, often in the form of whole or universal life insurance, that builds cash value over time. This cash value can be accessed during retirement to supplement income and can offer tax advantages that are not available with traditional retirement accounts like 401(k)s or IRAs.
A LIRP operates like a typical life insurance policy with one key difference: its ability to accumulate cash value. Premiums are paid into the policy, which covers the death benefit, and any excess goes toward an investment component. Over time, this investment grows, and the policyholder can borrow against or withdraw the cash value for retirement income. The death benefit remains intact as long as the policy is active, ensuring that beneficiaries are financially protected.
An LIRP can be a powerful tool for retirement planning in a number of different situations. Individuals with high incomes who have already contributed the maximum to other retirement accounts may find the tax advantages appealing. It can also be an effective solution for those seeking both life insurance coverage and a tax-efficient way to build wealth.
What Is an IUL?
As a type of permanent life insurance, indexed universal life (IUL) insurance combines a death benefit with a cash value component, offering both protection and the potential for growth. Unlike term life insurance, which only provides coverage for a set period, IUL offers lifelong coverage as long as premiums are paid. The cash value in an IUL policy can accumulate over time, and the policyholder can borrow against it or use it to pay premiums.
At its core, IUL functions similarly to other universal life insurance products, but it stands out due to its unique investment component. The cash value in an IUL is linked to the performance of a stock market index, such as the S&P 500. Rather than investing directly in the stock market, the policy ties the interest earned to the index’s performance. This allows for the potential of higher returns compared to traditional life insurance policies while protecting against significant losses through interest rate floors that ensure a minimum return, even if the index underperforms.
IULs often appeal to individuals looking for both life insurance protection and a way to accumulate wealth. It can be a suitable option for those who want to participate in potential market gains without the full risk of investing directly in stocks. It’s also attractive to those seeking flexibility in premiums and the ability to tap into cash value during their lifetime.
However, it is important to understand the potential fees, limitations and complexity before committing to an IUL policy.
LIRP vs. IUL: Pros and Cons
When comparing an LIRP with an IUL, it’s important to weigh both the pros and cons.
An LIRP provides tax-free income in retirement through the cash value of a permanent life insurance. Its main benefit is the predictability of cash value growth, which follows a fixed schedule and is not affected by market fluctuations. This steady growth offers more consistent returns, making it suitable for those seeking stable retirement income.
Another benefit is tax efficiency. LIRPs provide tax-free withdrawals during retirement, making them a useful supplement to accounts like a 401(k) or IRA. They also have no income limits for contributions, allowing high-income earners to contribute even if they have maxed out other retirement savings options.
Despite these benefits, you should also note that an LIRP can be limited in terms of growth potential. Since the cash value grows on a fixed schedule and does not participate in market gains, the returns can be relatively modest. Over time, this can be a drawback for those seeking higher growth to keep pace with inflation or for individuals with longer retirement horizons.
LIRPs also tend to come with higher fees when compared with traditional retirement plans. The cost of insurance, administrative fees and other policy charges can eat into your cash value, making it less appealing if you are looking for more cost-effective retirement solutions.
An IUL policy, on the other hand, could offer a higher growth potential by linking the policy’s cash value to a stock market index, such as the S&P 500. This means that during periods of market growth, the policy’s cash value can increase significantly, offering a more efficient way to build wealth over time. Additionally, policyholders can adjust their premiums and death benefits over time, allowing them to adapt to changing financial circumstances. Like LIRPs, IULs also offer tax-advantaged growth and tax-free withdrawals, making them a useful tool in retirement planning.
But, higher growth potential with an IUL also means higher risk. While the cash value of an IUL is linked to market performance, it also means it can be more volatile. Market downturns can result in lower or even zero growth in some years, which can be an issue if you are counting on that money for retirement. IULs come with caps on the amount of market gain you can benefit from, which can limit your returns. Like LIRPs, IULs also come with fees and expenses that can reduce the overall cash value over time, potentially making it a more expensive option for those seeking higher returns.
Bottom Line
An LIRP funded by an IUL could help diversify your retirement portfolio by combining life insurance with growth potential. Tax-free withdrawals from the cash value can supplement retirement income and the death benefit adds protection for beneficiaries. This combination provides growth, tax advantages and protection. The choice between an LIRP and an IUL depends on your financial goals, risk tolerance and retirement strategy.
Tips for Retirement Planning
- If you want to create a retirement plan, a financial advisor can work with you to pick investments and manage your portfolio. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- To find out how much your retirement savings could grow over time, SmartAsset’s free retirement calculator could help you get an estimate.
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