But, is it a real either/or decision? Let’s review each.
Features and Benefits:
The IUL, a hybrid product that combines life insurance with an investment component – or so it seems. In fact, it’s returns come in the form of credits to cash value paid by the insurance company – the size of which can vary from year to year. How much the insurance company credits is usually tied to the performance of some outside index and comes with limitations to the upside, called a ‘cap’, and, in many cases, protection against loss on the downside, called a ‘floor’. So, typically, an IUL offers the potential for tax-deferred growth up to the cap and limits loss often to 0. There’s also a death benefit, which is generally tax-free.
The Roth IRA comes with a straightforward approach: You contribute after-tax dollars, and your investment grows tax-free. It offers flexibility, allowing you to withdraw your contributions at any time after five years without penalty (there are holding requirements and earnings may be subject to taxes and penalties if withdrawn before age 59½). So, no limits on the upside – but also the same holds true for the downside and any ‘death benefit’ is simply whatever’s left in the account. They have some limitations, too. You can’t contribute if your income is 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.
There’s more: 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.
Performance and Returns:
Many IUL marketers claim the IUL will provide the best of both worlds: the potential for market gains and a safety net during market downturns. This isn’t really a realistic depiction, though. The reason is simple. IUL premiums, after the cost of insurance, are typically invested by the insurance company in government treasury bonds and other safe investments, with a small portion used to purchase options on the stock market. This combination, along with risk pooling, allows the insurance company to protect policyholders against loss. The trade-off for the safety is the cap on gains. As a result, I tell clients that their long-term return will likely be closer to those of intermediate bonds, and you’ll have a tax-free death benefit for your heirs. I’ve written about tax planning before.
On the other hand, the Roth IRA is really a ‘drawer’ in which investments are held, so you have wider flexibility. The return realized depends on the investments held inside. If the investment is, for example, an index fund, you’ll receive whatever returns the index fund generates. No cap. No floor. At death, heirs get what’s left.
Flexibility and Access:
For the IUL, this can vary from company to company – and depends on the policy design. There are some designs that provide for early cash build-up with more available liquidity than many people need. Other designs place more emphasis on legacy build-up (for heirs). Liquidity is usually achieved by withdrawals (up to the deposit level) then through policy loans, which are also tax free. Money can be withdrawn for any reason and there’s no legislative holding requirement and no age 59-1/2 penalty issue. Different companies have different designs and limitations. It’s wise to have an independent professional guide help you with this.
The Roth IRA allows you to withdraw your contributions without penalty as long as the account holder has held the account for five years and has turned 59-1/2.. It’s like having a genie in a bottle, granting your financial wishes whenever you need them. Just be cautious not to abuse this power, or your retirement dreams might vanish as quickly as the genie itself.
It’s Not Either/Or
Here’s something to consider: for the long-term investor with a sizable bond allocation, an IUL can make sense for a portion of these long term assets. In terms of funding order, it might make sense to (1) fund retirement accounts up to the maximum allowable amount, then (2) fund an IUL for late-life income (with an added legacy benefit). The IUL portion of the portfolio could be considered part of the long-term bond allocation of the portfolio. Here’s more information for making your money last.
Conclusion:
Is this right for you? Maybe. Maybe not. You wouldn’t build a house without a blueprint; your financial house should be no different.
You might want to sit down with a CFP® professional to develop a plan. Decisions in one area can affect others. Coordination is critical for avoiding expensive mistakes, like decisions involving Social Security, for example.
I hope this has opened the door for you to begin asking questions and doing your homework.
Jim
