If you’re like most people in the United States, there’s a good chance that you know what a 401k plan provides. You may not have heard about an IUL.
Let’s take a closer look at these two retirement options.
An IUL is an indexed universal life insurance policy. This type of life insurance gives you a flexible premium to pay each month. There is a death benefit that is paid out, a savings feature included with the policy, and you can change the amount of the premium over the life of its contract.
A 401k plan is based on the portion of the U.S. tax code to which it is associated. Most individuals become eligible for this tax-advantaged retirement plan because their employer offers one. Self-employed individuals have access to a similar plan that they can fund on their own. If you have a Roth 401k, then you pay your taxes upfront and can withdraw them without future tax liability with its growth.
It is important to know the key differences between an IUL vs a 401k plan to know which retirement option is the best one to meet your needs.
What Are the Differences Between an IUL and a 401k Plan?
There are 7 key differences to consider if you’re looking at an IUL or a 401k plan to help you save money for your retirement.
1. An IUL is an insurance policy.
A 401k plan is an investment product. An IUL is an insurance policy. With the IUL, you are gaining financial protection over your current wealth. Investment products work toward growing your overall net worth. Many households use a combination of both products to secure their financial future. Both options offer the potential for gains, but a 401k plan might be cheaper to manage for some individuals.
2. An IUL provides certain guarantees.
Because an IUL policy is insurance, you’re given certain guarantees about the performance of the policy. You can include no-lapse guarantees, death benefit guarantees, and several additional riders that can protect the finances of your household during unexpected circumstances. A 401k plan does not offer a protection from loss, even though there is no earnings cap currently in place with this retirement option.
3. An IUL does not have contribution caps in place.
The U.S. tax code places contribution limits on 401k plans each year. In 2018, for example, employees are able to contribute $18,500 to an employee-sponsored 401k plan. If you are 50+ years of age, you’re permitted an additional $6,000 in catch-up funding for your retirement. Employer contributions to a 401k plan are capped at $36,500 per year in 2018 as well. With an IUL policy, you’re not capped whatsoever. You choose the value of the policy you want. It then provides you with permanent life insurance that is tied to a major stock index. You may have a maximum or minimum return percentage that applies to this product as cash accumulation occurs.
4. IUL policies can be difficult to understand.
A 401k plan is a pretty straightforward product. You save money out of your paycheck or make direct contributions to it, either pre-tax or post-tax. If you are employed, then your employer can make contributions as well. With an IUL policy, there are numerous riders and options for you to consider. Although this allows you to customize a policy to meet your exact needs, you will also have several additional pages of terms that you must understand to be fully aware of what your policy will provide.
5. IULs have different tax treatment policies.
Because the cash value of your IUL has already been taxed, you can access the value of your policy at any given time. To receive the tax advantages of a 401k, you may be required to wait until the age of 59.5 to make a withdrawal. At a certain age, you’re also required to take monthly distributions from your 401k. Although Roth products are a little more relaxed in their requirements since it is a post-tax 401k, you’ll still need to follow the age and distribution rules to avoid paining any penalties.
6. IUL policies avoid probate.
All 401k plans in the United States are subject to the probate process. If you invest into an IUL policy, then your designated beneficiaries will receive the death benefit without the probate issue looming over them.
7. IULs do not receive an employer match.
An IUL policy is something that you purchase on your own. With a 401k plan, it is often an employee benefit, sometimes optional, that employers may use to give you a certain matching percentage of your contributions. If your employer offers a 4% non-vestment match, then a $4,000 contribution to the 401k plan would create a matching contribution of $160.
Is Whole Life Insurance the Right Investment to Make?
An IUL is a whole life insurance policy. That means you’ll be able to take advantage of the fact that it covers you for life. It will also build a cash-value accumulation over the lifetime of the policy.
You may be asked to complete a health examination as part of the application process with the IUL. Some policies can be purchased without an exam, but it does come at a higher cost if you choose that option.
It is important to remember that time is required with this type of insurance investment. Many IULs require between 12-15 years to hold a reasonable cash value that becomes an asset for your finances.
Your cash value in an IUL is based on the return your investments earn. If the index it is tied to performs well over the course of a decade, the returns can be fantastic. If the index slides, the cash accumulation could be negligible. For that reason, it is important to purchase a policy which offers a minimum return guarantee.
You can withdraw a portion of the cash value in a whole life investment or borrow against it during the life of a policy.
When compared to term life insurance products, the premiums are sometimes more expensive. If you keep the insurance active over several years, however, the value of the policy may be worth more.
For some households, a term life policy is a better investment choice than a whole life IUL policy. With a term-life policy, you’ll receive only a death benefit. It will pay that benefit if the policy is in effect when the death occurs and meets any stipulations, like a 2-year suicide waiting period.
You purchase term life insurance based on a specific time period. Some policies may be in effect for just 1 year. You can also purchase blocks of 5-year multiples with most providers.
Because the risks of death are higher as you age, the cost of a term life policy increases dramatically after the age of 50. That is why an IUL is a better option for many households in the 50+ age category.
You may wish to check with your current term life insurer because some policies can be converted into whole life insurance. One of those options may be an IUL.
Provisions to Consider in the IUL vs 401k Comparison
With a 401k plan, you may be limited to certain categories of investment to grow your wealth. Common categories are labeled with terms like “conservative” or “moderate risk.” You choose the percentages you want, then the administrator of the retirement plan makes the investments based on your preferences.
Many IULs suffer from a reputation that suggest a lack of transparency. Because the terms of an IUL can be extensive, many investors don’t take the time to read all of the included provisions. One IUL provision that garners a lot of criticism is the ability of a company to lower the cap of returns to strengthen their balance sheet.
Projections are a common staple with 401k plans and IULs too. Many IUL salespeople have come under criticism for basing projections on unrealistic market expectations, but that is true for retirement plan salespeople as well.
The best advantages of an IUL are seen with those who have a high net worth and want to avoid extensive estate taxes for their heirs. This option creates a tax shelter that helps to protect the value of the estate over time.
For some individuals, an IUL and 401k work together to create a strong retirement. For others, the comparison of an IUL vs a 401k plan is important to consider because each has the power to create the retirement lifestyle that is desired.
As with any retirement product, it is important to weigh all the pros and cons of each product to determine which can best meet your needs.