Most financial advisors you talk to will stress the importance of planning for retirement. To make sure you have enough retirement savings, you need a plan. Most of us want to maintain the same standard of living we have during our working years. When we look at income streams in retirement, tax-free income sounds great. We want to settle the IUL vs Roth IRA debate here.
Here, we will outline the case for an IUL vs Roth IRA.
The U.S. Department of Labor states that most Americans will need between 70% and 90% of what they were earning before retirement to maintain the standard of living they are accustomed to once they step into retirement.
What’s even more concerning is when you learn that a third of homeowners between 30 and 60 won’t be able to maintain their standard of living after they retire. This includes individuals who decide to put off retirement until they are 70.
Quite frankly, these results are the result of a lack of preparation. Many Americans heading into retirement bring significant debt that consumes a considerable portion of their retirement income, thus having a major impact on their standard of living during the first 5 or 10 years of retirement.
IUL vs Roth IRA for your retirement savings
Fortunately, financial products are available to help build the substantial retirement savings we’ll need when we enter our retirement years. For example, a Roth IRA and Indexed Universal Life (IUL) insurance are great tools that can be used to build a considerable amount of retirement savings.
Since the money we contribute to either of these products is with after-tax dollars, any distributions are typically received tax-free.
The Roth IRA and the IUL are similar but not the same. It is their differences that make them most appealing to people who have different needs. The product you choose will depend on your circumstances and your financial goals. You can have both. Many of our clients use a combination of a Roth IRA and an IUL.
Roth IRA
The Roth IRA is a retirement account funded with after-tax contributions (non-deductible on your income taxes). Using after-tax contributions allows the account owner to withdraw funds at a future date that are tax-free as long as you play by the rules. You can access your retirement savings at any age if certain requirements are met.
Qualified distribution in a Roth IRA vs IUL?
A qualified distribution would be a tax-free and penalty-free distribution from your Roth. The basic requirements for a qualified distribution are:
- Five-year rule – You must have held your Roth IRA for at least five years since your first contribution.
- Certain Exemptions – If you become permanently disabled, you could take a qualified distribution.
- Age 59 1/2 – If you are 59 1/2 and have held your Roth IRA for over five years, you may take a qualified distribution and avoid penalties and taxes.
- Death – When you die and have money in a Roth IRA, the money will pass to your beneficiary income tax-free.
An IUL, on the other hand, has no such rules to access your funds without a penalty.
What are the contribution limits for a Roth IRA vs. IUL?
The contribution limit for 2024 into a Roth IRA is $7,000, or if you are over age 50, it is $8,000. Remember that your income level also determines whether you can contribute to a Roth. For example, if you are married and filing jointly, and your income is above $240,000, or a single filer is making over $161,000, you can’t contribute to a Roth IRA. This makes the IUL a popular option among high earners since there is no income or contribution limit.
There are no contribution limits in an IUL like we have in the Roth IRA. The only contribution limits are going to be based on the financials of the IUL purchaser. These limits will come in the form of financial underwriting by the insurance company. Life insurance companies will look at the total financial picture and determine if the premium the IUL policy owner wants to pay is sustainable.
The best candidates for a Roth IRA vs IUL
A Roth IRA or an IUL will be a good choice of retirement vehicle for individuals whose tax rate will likely be higher during retirement than what they are paying now. This group of individuals will primarily consist of lower-income workers who are younger and will not be impacted by missing out on the upfront tax deduction but will likely benefit after many years of compounded growth that is tax-free.
Both a Roth or an IUL can also be appealing to individuals who wish to reduce their tax liability during retirement, and it is appealing to older and wealthier individuals who want to leave money to their heirs, which is tax-free.
Where the Roth IRA makes very good sense for individuals looking to save early to accumulate tax-free savings for retirement, you are limited as to how much you can contribute. The IUL may be the better choice for individuals looking to save more in a tax-free vehicle than a Roth allows. The goal is to maximize a tax-free income during retirement years.
Retirement savers using an IUL should also consider the following:
- A built-in Safety Factor – Individuals who fear losing money on higher-risk investments will feel much safer knowing that the floor in their IUL mitigates the risk of losing part or all of your investment in a down market.
- Save Returns – You only participate in the market’s upside, with no downside risk.
- Permanent Life Insurance – Since IUL is life insurance, you are able to spend your money and still leave a death benefit to your beneficiaries.
- Cash Flow that is Tax-Free – Like the Roth IRA, distributions from your IUL will be income tax-free.
Unlike the Roth IRA, an IUL serves more than one purpose. Since IUL is a life insurance policy, the cash value inside the policy will compound on itself while deferring taxes on the growth. An IUL could be an excellent choice for individuals needing life insurance and a way to save for retirement in a tax-favored vehicle. Many life insurance companies offer IUL policies, but not all companies are alike. We can guide you as to what IUL company is best to work with based on your individual needs.
An IUL policy offers a death benefit but allows the policyholder to generate interest based on how the cash value is allocated. There are many indexes with many companies. Some of the most popular index allocations will be the S&P 500, NASDAQ, DOW, and other proprietary indexes. We see new indexes enter the market all the time. Some of the most recent are Fidelity, Barclays, Pimpco, and Bloomberg.
Although there is a cap on the amount of interest that can be credited to an IUL account, there is also protection from downside risk. We just experienced a market decline over the last couple of years. The worst that can happen to your savings in an IUL is you get zero return in a down market year. IUL policy funds can also be allocated to a fixed account, earning a guaranteed rate of interest. One popular company currently pays over 5% on fixed account funds.
IUL vs Roth IRA
We like both. We have explained the basic differences between a Roth vs IUL. One may work better than another based on your circumstances and financial goals. If you are in the group of Americans who think taxes will increase in the future, skipping the tax deduction today for tax-free income later makes sense.
In either case, it’s certainly wise for you to speak with our advisors to learn what your options are. We can help with both. It starts with a conversation to determine what you are looking to accomplish. Once we know you better, we can show you options for both and compare them with our IUL/Roth comparison software.
Frequently Asked Questions
What are the key differences between an IUL and a Roth IRA for retirement savings?
A Roth IRA is a retirement savings vehicle offering tax-free growth and withdrawals, suitable for individuals looking for a straightforward way to save for retirement. In contrast, an IUL is a life insurance product with a savings component that is linked to a stock market index, offering the potential for cash value growth and tax-free distributions along with a death benefit.
How does the 2024 Roth IRA contribution limit compare to the savings flexibility of an IUL?
The 2024 Roth IRA contribution limit is set at $7,000 for individuals under 50 and $8,000 for those 50 and older. This cap restricts the amount you can save annually in a Roth IRA. Conversely, IULs do not have such contribution limits, providing more flexibility in the amount you can save, especially for those looking to save more aggressively for retirement.
Can I use both an IUL and a Roth IRA for diversifying my retirement portfolio?
Absolutely, combining an IUL with a Roth IRA can offer a diversified approach to your retirement planning strategy. While the Roth IRA allows tax-free growth within contribution limits, an IUL provides life insurance coverage and the potential for cash value accumulation based on market indexes. This strategy can balance the benefits of both, aligning with your financial goals, risk tolerance, and liquidity needs.
