If you’re torn between getting a life insurance policy and investing in the stock market, an indexed universal life (IUL) policy can serve both purposes. This product provides a death benefit to your heirs and returns based on index fund performance. On the other hand, a Roth IRA provides retirement income and may include more investment options than an IUL. So, how can you choose between the two? Read on to see which fits your situation.
For more help deciding how to go about planning for your retirement, consider working with a financial advisor.
What Is an IUL?
Indexed universal life (IUL) insurance provides lifelong coverage while building cash value over time. IUL policies differ from other universal policies because they offer growth through an equity index account, allowing for growth based on market performance. Like with other universal life policies, once enough cash value has accumulated, you can apply it to premium payments without losing the death benefit.
With an IUL policy, the cash value can grow by investing in an equity index account, such as the S&P 500, instead of relying solely on non-equity earned rates. This feature allows for potential growth that follows the stock market or specific economic sectors. In addition, although the returns are variable, IULs usually have a minimum guaranteed interest rate, so your account won’t stop growing in a market downturn. As a result, IULs offer steady, if occasionally lower, returns. These accounts often have “caps,” which limit the maximum interest the policy can earn during market upswings.
Lastly, IULs use dollars the government has already taxed. In other words, during your career, you’ll pay premiums from your bank account instead of taking the amount from your paycheck before taxes, as you would with a traditional IRA. In addition, your beneficiaries will receive the death benefit tax-free unless they turn the lump sum into an annuity or the payout surpasses the federal estate tax limit.
What Is a Roth IRA?
A Roth IRA is a retirement account that invests your money in stocks, bonds, mutual funds, and more. Unlike traditional IRAs, Roth IRAs use post-tax money. This characteristic means you won’t reduce your income taxes while working, with the upside being you won’t owe a penny of income taxes on distributions when retired.
However, your income can prevent you from contributing to an IRA if it’s too high. For example, someone filing single on their taxes must earn less than $153,000 in 2023 to contribute to an IRA, while married joint filers lose the ability with an income of $228,000.
Furthermore, both traditional and Roth IRAs have annual contribution limits if you have $6,500 or $7,500 per year to invest. As a result, you must put money into another account type if you have more than $6,500 or $7,500 per year to invest.
Finally, governmental rules determine when you can take earnings from your IRA. If you’re younger than 59.5, you’ll incur a 10% penalty plus taxes when withdrawing earnings from a Roth IRA. This penalty also applies to accounts that are less than five years old. However, once you reach the required age and have held the account for five years, you can withdraw whatever amount you want at any time without penalty. You can withdraw your contributions without penalty at any time.
Comparing IUL and Roth IRA
IULs and Roth IRAs are assets that provide investment growth. However, they offer different advantages and disadvantages, as outlined below:
Earnings and Risk
IULs may limit both your losses and gains. Specifically, your rate of return may only drop so far before leveling out, and the index performance may also hit a cap, meaning your interest rate won’t exceed a specific number. While this characteristic may provide security, it could prevent your funds from maximizing their earning potential.
On the other hand, Roth IRAs offer more asset types and diversification. Furthermore, IRAs don’t have performance caps, meaning your investments are free to soar with the market. However, you’ll also experience the according losses during market volatility.
Deposits to IULs and IRAs share similarities while remaining distinct. Specifically, you fund an IUL through monthly, quarterly, biannual, or annual premiums. Paying annually may provide a discount on your total premium. In addition, missing a payment might nullify the entire policy, depending on your insurance company and contract.
Remember, a whole life insurance policy has more expensive premiums than term life insurance. Plus, if you start a policy when you’re older or have a medical condition, your premiums will be higher. Lastly, premiums do not reduce your income taxes and are not tax deductible.
Similarly, Roth IRA contributions don’t create any tax advantage because they also use post-tax dollars. However, Roth IRA deposits can be in any amount, up to the annual limit, and you can contribute as frequently as you want without endangering the account’s status.
That said, the more you deposit to a Roth IRA, the larger it may grow. However, federal law limits your contributions to $6,500 or $7,500 if you’re over 50. On the other hand, you can contribute to an IUL as much as you’d like. An overfunded life insurance policy simply gains more cash value, making the future payout bigger.
Retirement accounts of all stripes charge administrative fees. However, these costs range broadly between companies and asset types. Therefore, whether you open an IUL or Roth IRA, it’s best to understand the fee structure before committing. Otherwise, fees can eat into your funds, diminishing your account’s value. So, shop around and research before opening a policy or account.
IULs distribute cash by paying your beneficiaries when you pass away. This benefit doesn’t incur taxes. However, you can also take a penalty-free loan from your IUL and pay the loan back with interest. In addition, you can surrender the policy, meaning you pay a fee to liquidate it.
Roth IRAs don’t allow penalty-free withdrawals of earnings until the accountholder turns 59.5 and has owned the account for five years. That said, if you have an exceptional circumstance, you can take money from your Roth IRA before the allowed time without penalties. For example, first-time home buyers can use the money for a down payment. In addition, you can use IRA funds for education expenses or the costs of a birth or adoption without a penalty.
Lastly, neither product has required minimum distributions (RMDs). This shared trait means you can leave the money in your account or policy without touching it for as long as you like without incurring taxes or penalties.
IULs don’t have defined boundaries for eligibility, but life insurance companies may deny you coverage if they think you’re too risky. Specifically, your age, overall health, lifestyle, career, financial circumstances, driving record and criminal record can provide reasons for insurance companies to refuse to sell you a policy. Likewise, these factors can increase your premium payments even if they don’t prevent you from purchasing a policy.
On the other hand, the only boundary for a Roth IRA is annual income. You need to earn an income to open one, but single filers making more than $153,000 in 2023 can’t open an account, while joint filers making $228,000 can’t open one.
Which Is Best for You?
Both Roth IRAs and IUL accounts provide tax-free distributions and unique advantages based on your age and circumstances. For example, while Roth IRAs can benefit the average investor, they are excellent for younger investors who anticipate their income will increase and do not require the tax deduction offered by traditional IRA investments. Instead, although income and investment limits apply, the funds grow tax free.
However, IUL investments are suitable for those who want to combine life insurance and investing with limited exposure to volatile markets. Policy caps and floors safeguard investors, and the life insurance payout can give heirs a sizable inheritance.
Overall, adding an IUL or a Roth IRA to your retirement portfolio can be a significant step toward achieving your investment objectives and meeting your family’s needs. Since both provide benefits, the best way forward will come down to the details. For example, a chronic health condition may make IUL premiums too expensive to be worth it. On the other hand, if your income level is too high for a Roth IRA, IULs have no income limits for eligibility.
The Bottom Line
IULs and Roth IRAs can both play a vital role in retirement planning. IULs have fixed premium costs, have an investing elemen and pay a tax-free lump sum to your beneficiaries. On the other hand, Roth IRAs have unlimited growth (and loss) potential and require no commitment for a specific contribution size or frequency. They also provide tax-free income in retirement. Therefore, investors concerned about their family’s welfare after they’re gone may prefer an IUL, while those who want a tax-free income stream during retirement can opt for a Roth IRA.
Retirement Planning Tips
- The plethora of assets and retirement accounts can make retirement planning a challenge. Because accounts offer various tax benefits, rates of return, and contribution rules, it’s crucial to pick those that fit your financial circumstances. Fortunately, you can work with a financial advisor to create a retirement plan that fits your unique situation. Finding one 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 interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- You can simulate your Roth IRA’s future performance with SmartAsset’s retirement calculator to see how well you’ll fare in retirement. Plus, you can factor in aspects like Social Security election age, marital status, and other retirement accounts to see where you land.
Photo credit: ©iStock.com/LumiNola, ©iStock.com/jacoblund, ©iStock.com/courtneyk