Comparing IUL vs. 401k for Retirement
Which Is Best for Your Retirement Goals
If you’re like most Americans, you’ve heard of a 401(k) but an IUL? Not so much. Before we look at an IUL vs. a 401(k) let’s define an IUL.
What Is an IUL?
An IUL, or indexed universal life insurance, is a type of universal life insurance policy. Universal policies have flexible premiums and the death benefit, savings feature, and premium can be altered through the course of the contract. Learn more about universal life insurance policies here.
One of the most important parts of indexed universal life policies is the cash component. Think of the cash component as a way for the policy to act like an investment product. The insurance company puts it to work by tying it to an index in the stock market. Either you choose from a menu of indexes or the insurance makes the choice. Let’s assume you picked the S&P 500.
If the S&P 500 goes up a certain percentage, the cash value of your policy goes up a certain amount—although not the same amount. IULs generally have a cap on the upside of the investment. If the S&P 500 had a year like 2017 where it was up more than 20 percent, depending on the terms of the policy, an IUL might have only returned a 12 percent gain for the year. Some of these caps are percentages. If they S&P is up 20 percent, you’ll earn 10 percent.
If you dig in to the fine print you might also see some the phrase, “point to point.” Instead of looking at the index’s performance each day, the insurance company will look at the performance at certain intervals. If it’s an annual point to point, it doesn’t matter what the index did throughout the year because the insurance company will only look at the index’s performance on December 31 or other set date. This could work in the policyholder’s favor or not, depending on the market.
Further, part of the gains of the S&P 500 include a dividend. In 2017, the dividend accounted for about 3 percent of gains. IULs don’t usually pay the dividend portion of the gains.
On the other hand, if the S&P had a year like 2008 when it was down 37 percent, IUL holders didn’t lose much sleep because the cash component of their policy wasn’t down at all—or with certain policies, still had a small gain. You won’t get the all of the upside with an IUL but you’re protected from the downside. That’s why it’s an insurance policy.
What Is a 401(k)?
A 401(k) gets its name from the tax code that its tied to. Most people become eligible for a 401(k) because they work for a company that offers one. Some portion of their paycheck goes into their 401(k) along with a company match, if offered. The employee can pick how the money is invested from a small menu of investment options. There are different types of 401(k)s—a Roth 401(k) where taxes are paid upfront or a traditional 401(k) where the money is invested on a pre-tax basis and tax later in life when the money is withdrawn.
IUL vs. 401(k)
Before making a decision on either, do a lot more reading on how each works but here are some key differences between the IUL and the 401(k):
IULs are insurance policies—401(k)s are investment products. Insurance policies are designed to offer protection while investment products have the goal of growing your net worth. Insurance policies and investments should be used together but some financial advisers advise keeping them separate. IULs offer both insurance and investment gains but the 401(k) may offer the investment gains at a lower cost. There’s no earnings cap on a 401(k) but there’s also no protection from loss.
Difficult to Understand: All financial products are difficult to understand to some extent, but insurance policies often have so many options and pages of fine print that consumers are at the mercy of their insurance agent. 401(k)s, while still complicated, are more straight forward and easy to understand.
Tax Treatment: The cash value of IULs can be accessed at any time because it’s already taxed. Some 401(k)s are different—you have to be 59 ½ before withdrawal, you have to take required monthly distributions at a certain age, etc. If you have a Roth 401(k), your rules are more relaxed but because the IRS is giving you tax breaks, you have to follow their rules.
Estate Planning: 401(k)s are subject to probate. With an IUL, beneficiaries get a death benefit.
Employer Match: 401(k)s often have an employer match—IULs do not.
Ask for Help
401(k)s get a lot more financial media attention than IULs so you probably have a better understanding of how a 401(k) works. IULs are very complicated and come with a lot of options. Find an insurance professional who can help you evaluate your options without having skin in the game.