Indexed universal life insurance
Indexed universal life insurance (or IUL) can be beneficial for retirement because it protects your savings from stock market fluctuations. It can also earn more money than a whole life insurance policy. IUL achieves this slightly higher return potential by utilizing index accounts that are linked to the movement of a market index. The real power of the product, however, comes from the fact that your index account can never return less than 0%. In other words, your index account(s) will never experience a loss as a result of a market crash. The most powerful weapon you have against running out of money in retirement is to invest a portion of your retirement savings in an asset that eliminates the sequence of returns risk.
Is Indexed Universal Life Insurance Beneficial in Retirement?
It is a cash value life insurance policy that pays an interest rate based on the return of a specific index over a specified period (typically one year). Each year, the insurance company determines the interest rate based on the movement of an index (usually a stock or bond index). This allows for significantly higher interest payments on cash than traditional fixed-interest insurance products while also protecting the policyholder’s cash from loss during bad economic times.
Retirement planning is one of the areas where indexed universal life insurance shines the brightest. The ability to earn well-above-average interest on a fixed-interest savings plan, combined with the unique features of life insurance policy loans–particularly indexed style loans–places IUL in a strong position to assist you in your pursuit of establishing reliable retirement income streams.
The product generates respectable returns while being far less volatile than traditional stock market investing. And, like all cash value life insurance, IUL protects you from principal risk during rising interest rates, which is a major concern for bond investors right now. Because of the lack of volatility in year-over-year returns, indexed universal life insurance produces more dollars in income per dollar saved/accumulated in retirement. In other words, you can do more to create retirement income with IUL while retiring with fewer total dollars than you can with traditional investments.
Is It Better Than a 401(k)?
One is not superior to the other. They both offer unique benefits that will be more or less appealing to an individual depending on their specific needs. 401(k) plans are unquestionably more widely available to average employees through their employers. Because of auto-enrollment, starting a 401(k) will likely be easier than purchasing an indexed UL policy for these people, who constitute a sizable portion of the U.S. population.
There is nothing wrong with choosing this route due to its ease of access as long as you understand the tax implications of your 401(k) savings. I don’t believe it is appropriate to ask whether an indexed universal life insurance policy is superior to a 401(k). Most people who ask this question do so because they have limited resources to set aside for retirement and believe they must choose between the two. If this is your situation, you should probably take a closer look at your current financial plan to see where you can find additional resources to save for the future.
The IUL will require more effort to find the best option for your needs, but it will also provide you with a variety of tax benefits that you may find useful.
Is it a wise decision?
While we don’t generally use the term “investment” due to the regulatory implications, this is a common question, so it’s important to address it. Over a period of 20 or more years, indexed universal life insurance will most likely produce a nominal return on premiums of around 5%. Depending on the indexing features available, some products may achieve a much higher return.
Given the tax advantages of cash value life insurance, the effective rate of return will be higher when compared to common taxable investment/savings plans (e.g., 401(k), traditional IRA, 403(b), and so on). This could increase your effective rate of return on an IUL policy by a few percentage points, depending on where your income falls in retirement. In other words, a 5% nominal return could result in a 7% effective rate of return after taxes.
We recently reviewed an indexed universal life insurance policy we sold over eight years ago and discovered that the policy’s average indexing credit has been 7.54 percent since inception, and 6.21 percent in the last two years. This puts the policy on track to achieve the aforementioned nominal rate of return.
Is it Possible to Lose Money?
You cannot lose money because of a market decline, but you can lose money in an indexed universal life policy if it pays no interest in a given policy year.
This is because IULs have ongoing insurance expenses that are deducted from the policy’s cash value. If the index that the policy tracks fall for the year, potentially resulting in no interest paid on the cash value, then the fees deducted from the policy would result in a small net loss for the year. In reality, this isn’t very common.
We manage dozens of these policies, and I can’t recall a single year when a policyholder experienced this. It is possible, but it is not a common occurrence and does not have a high probability of resulting in long-term losses. Having said that, some people purchase indexed universal life insurance and then cancel the policy.
This is since the policy will seldom have a positive return on cash value within the first few years. Furthermore, these policies, like nearly all universal life policies, have surrender charges. So, if you’re going to invest in IUL, you should do so with the understanding that it’s a long-term commitment, or you risk losing money.