Every financial planner you speak with is going to be adamant about how retirement planning is critical for all of us to maintain our financial security and plan for a standard of living that is realistic. And, we can certainly agree that the majority of Americans are concerned to some extent that they will be able to maintain a satisfying standard of living throughout their retirement years.
This concern is justified by estimates provided by the U.S. Department of Labor which state that most Americans will need somewhere between 70 and 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 preserve 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.
How to Overcome
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 invest in either of these products has been taxed already, any withdrawals we make are typically made tax-free. They are similar because the account owner can accumulate savings for retirement at a lower rate than they typically would in the future.
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.
The 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. Since the money in your Roth IRA belongs to you, you can withdraw your contributions (not the earnings) at any time on a tax-free and penalty-free basis.
Certainly, we could add another 2,000 words about the rules, regulations, and specifics of the Roth IRA, but instead, let’s jump to the reason for the article: “Who will benefit the most from a Roth IRA?”
Who Will Benefit the Most from a Roth IRA?
A Roth IRA will be the better 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.
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 (IUL)
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.
An IUL policy not only contains a death benefit but also allows a policyholder to invest the portion of their premium not used to purchase life insurance in an assortment of popular indexes like the S&P 500 and the Nasdaq 100.
What makes an IUL different from other types of permanent life insurance is that the policy’s cash value is dependent on the performance of the equity index (excluding dividends) and is restricted by the policy’s cap and floor instead of being dependent on a static crediting rate that’s been established by the insurance company.
Although there is a cap on the amount of interest that can be credited to the policyholder’s account, there is also a safety valve called a “floor” which protects the policyholder from losing money in a down market. Again, rather going on and on with rules and regulations that will ultimately confuse the reader, let’s jump to the reasons why an IUL might be a better choice for your retirement planning than a Roth IRA.
Who will Benefit the Most from an IUL and Why?
Where the Roth IRA makes very good sense for individuals looking to invest early and accumulate substantial savings for retirement, the IUL make be the better choice for individuals looking to maximize a tax-free income during retirement years, plus there is the life insurance component that satisfied a need for virtually anyone. Investors 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 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.
Roth IRA vs. Indexed Universal Life
Hopefully, this article explained the basics about each product and why one may work better than another based on your circumstances and financial goals. If you are in the group of young adults who are interested in saving for retirement and not concerned about missing the tax deduction by using after-tax money, the Roth IRA may be the better choice.
If however, you want a product that provides the dual purpose of life insurance and retirement planning and you are concerned about your income level during your retirement, and knowing that your savings will not be subject to market volatility, the IUL may be a better choice.
In either case, it’s certainly wise for you to speak with a retirement planning professional to learn what your options are and receive illustrations indicating how your investment can work for you over time.