Most financial advisors you talk to will stress the importance of planning for retirement. In order 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. The most popular ways to generate tax free income is with an IUL or a Roth IRA.
Here we will be laying out the case for an IUL vs Roth IRA.
The U.S. Department of Labor states that most Americans will need between 70% to 90% of what they were earning before retirement in order 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 with them 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 or Roth for retirement savings deficit
Fortunately, there are financial products 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 made tax-free.
The Roth IRA and the IUL are similar but not the same. It is their differences, in fact, that makes them most appealing to people that have different needs. The product you choose will depend on your circumstances and your financial goals.
Roth IRA
The Roth IRA is a retirement account that is funded with after-tax contributions (non-deductible on your personal 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. In fact, you can access your retirement savings at any age as long as certain requirements are met.
What is a qualified distribution in a Roth IRA?
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 or old and you have held your Roth IRA for over 5 years, you may take a qualified distribution and avoid penalty and taxes.
- Death – When you die and have money in a Roth IRA, the money will pass to your beneficiary income tax free.
What are the contribution limits for a Roth IRA?
The contribution limits for 2023 into a Roth IRA is $6,500 or if you are over age 50 it is $7,500. Now keep in mind that your income level also plays a role in weather you can contribute to a Roth. For example, if you are married filing jointly and your income is above $228,000 or a single filer making over $153,000 then you can’t even contribute to a Roth IRA. This makes the IUL a very popular option among high earners since there is no income or contribution limit.
Who Will Benefit the Most from a Roth IRA?
A Roth IRA will be the better choice of a 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.
The Roth IRA 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 that is tax-free.
Indexed Universal Life Insurance or IUL
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. IUL policies are offered by many life insurance companies but all companies are not 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 also 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 into 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 in 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 amount of interest. One popular company currently pays 5% on fixed account funds.
IUL Contribution Limits
There really 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 policyowner wants to pay is sustainable.
Who Will Benefit the Most from an IUL and Why?
Where the Roth IRA makes very good sense for individuals looking to invest 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 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 or your investment in a down market.
- Earn Higher Returns – With an Indexed Universal Life policy, if the indexes you’ve chosen perform well over the crediting period, you may experience higher earnings.
- 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.
IUL vs Roth IRA
We have explained the basics of each option and why one may work better than another based on your circumstances and financial goals. If you are in the group of Americans that 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
Who should use a Roth IRA for retirement planning?
A Roth IRA will be the better choice of a 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.
Why invest in Indexed Universal Life instead of a Roth IRA?
Unlike the Roth IRA, an IUL serves more than one purpose. Since it is an insurance product and an investment product, an IUL makes an excellent choice for individuals needing life insurance and a vehicle to accumulate significant savings for their retirement.
What are the best reasons for choosing an IUL?
We believe that an IUL policy is the better choice for many reasons. Here are four very important ones:
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 or your investment in a down market.
Earn Higher Returns – With an Indexed Universal Life policy, if the indexes you’ve chosen perform well over the crediting period, you may experience very attractive earnings.
Permanent Life Insurance – Unless you are suffering from major health issues, the life insurance coverage in your IUL is competitively priced and is protection that you would have needed anyway.
Cash Flow that is Tax-Free – When you consider the tax burden that may result from other popular investment products, the IUL eliminates this burden because cash flow can be generated by accessing the funds that accumulate in the policy through contract loans that are made tax-free.
