401(k) Retirement Accounts Or Indexed Universal Life Insurance?

Please note: I have updated this article with the following two articles –

The Advantages and Disadvantages of a 401k

The Advantages and Disadvantages of an IUL

401(k) Retirement Accounts Or Indexed Universal Life Insurance?

Many Americans face a difficult choice when planning for their futures.  The government has endorsed the use of individual retirement accounts (IRA), the 401(k) plan, and other “tax qualified” retirement accounts as vehicles to build cash value that can be used in retirement to supplement our savings, home equity, and social security earnings.  But relatively few people are considering the use of indexed universal life insurance for the same purpose.

You don’t have to look hard to find people who believe that “you should only buy term insurance” and “insurance can’t fund your retirement”, especially since insurance is paid for with after tax dollars.  All of the tax qualified retirement accounts allow money to be deposited tax free in the year they are earned.  So the question is whether or not there’s any reason to even consider indexed universal life insurance for retirement purposes.

Let’s look at the arguments in favor of life insurance but keep in mind that I’m a licensed seller of real estate and life insurance.  I’m not an accountant, a lawyer, or a securities dealer.

1. Permanent life insurance (whole life, universal life, indexed universal life, etc) builds a cash value over time that grows tax-deferred, similar to the qualified retirement accounts.

2. If you die before reaching age 100, life insurance provides a tax-free payment to your beneficiary.  With the qualified plans, if you are unmarried, your 401(k) is often taxed as regular income to your beneficiary in the year received, a huge tax burden.

3. The cash value that builds in permanent insurance is an asset that can be accessed free of income taxes or penalties using zero-cost policy loans.  The loan does not need to be repaid until you die.  These loans can be used for any purpose, such as college expenses for your kids, car repairs, vacations, etc.  Funds in  qualified retirement accounts normally cannot be accessed prior to age 59 1/2 without incurring a 10% penalty and income taxes.

4. Premiums for indexed universal life insurance can be increased to allow the cash value to grow larger and faster and there are few limitations on the amounts.  In many tax qualified retirement savings plans, there are limitations to how much you can deposit.

5. The cash value in a life insurance policy can grow without any requirement to take money out.  This gives you the option to let your funds build.  In qualified plans, you are required to take out a minimum amount beginning at age 69 1/2 and every year thereafter.  The government doesn’t want to wait for its share.

6.  When you use the cash value for an income stream in retirement, you will normally receive the money free of income taxes.  When using a qualified plan for retirement, the income is fully taxable by the state and federal governments.  Some people think that the tax deferred status given to their deposits is a big deal but, if you do the math, you’ll find that the meager taxes saved prior to retirement are often paid back in less than four years in retirement. In addition, most retirees have fewer tax deductions since the kids have left and the house is paid off or has a low balance.  If you live a normal lifespan, you’ll find that you’ve paid $100s of thousands of dollars more in taxes than if the same money had been put into a life insurance policy.

7. The cash value in an indexed universal life insurance policy grows with little risk.  The growth in these accounts is normally tied to an index like the S&P500.  When the market value goes up, your account goes up (to a cap).  When the market goes down, your account stays the same (it has a floor).  You cannot lose value due to the market and you never need to make any decisions about the account.  During the “lost decade” from 2000 to 2010, when the S&P500 essentially stayed flat, users of indexed life accounts earned an average of over 9% per year because they only participated when the market went up, not when it went down.  Use of a qualified plan requires the worker to either become an expert on investing or trust his account to the skills of strangers.  Since the market has often gone down in recent years, this means the balances in many retirement accounts has gone down by large amounts.  This can be devastating to somebody planning to retire soon.

8. When properly set up and funded, an indexed universal life insurance policy will provide a tax-free income for life that does not vary.  Many users of qualified plans have found that their accounts do not provide the income they hoped for (either because the balance did not grow as much as they expected or they underestimated the income tax burden), or the money runs out before their life does, requiring them to find jobs at places like Walmart and fast-food restaurants, where they are much older than their co-workers, or to rely on family or charity to make do.  This is a tragedy that is happening to more people every year.

So, what do you think? Have I been unfair to the qualified retirement accounts?  Are there benefits to using a 401(k) that an indexed universal life insurance policy does not have?  Please add your comments and opinions down below.

 

 

 

 

 

 

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14 Responses to 401(k) Retirement Accounts Or Indexed Universal Life Insurance?

  1. Leo says:

    I totally disagree with item #1 that permanent insurance plans grows tax deferred program. You shouyld be very careful in publishing your article. You probably not aware about IRC 7702 (a). Insurance like Global Indexed Universal Life is 100% Tax Free as long as you dont over fund your premium.

    • Michael says:

      You’re right about the law that restricts overfunding your premium (creating a “modified endowment contract”). But as long as the premiums do not violate the “seven pay test” (and if the policy is set up properly, they won’t), the cash value DOES build with taxes deferred. Better still, by utilizing zero or low-cost loans, the cash value can be accessed without taxes or penalties when the money is needed; such as for emergencies or retirement. Try that with most “qualified” retirement accounts.

      Assuming a rate of return that is anywhere near the historical averages, the holder of one of these policies is likely to die and leave a generous tax-free estate to his family or other heirs, or will enjoy a tax-free retirement for as long as he lives. If retirement lasts for more than 3 -4 years, the savings from a tax-free retirement income will outweigh the initial savings achieved by making tax-deferred deposits in a “qualified” account (which will be taxed as regular income when used for retirement or (for many people) will be taxed as regular income if left to heirs).

  2. marlon manuel says:

    To Leo,

    As an agent setting up a EIUL to your clients, it is your best interest to make sure that they dont violate the IRC 7702. That is why he mention ” if set up properly”.
    Regardless if the policy is a MEC or non-MEC,the cash value grows tax deferred. For MEC any cash that is taken out of the policy is taxable WHEN you take it out not while it is being earned.
    But the Death benefit or Face amount is tax free regardless MEC or non- MEC. Good article Michael.

  3. Denise says:

    Great article! And yes you absolutely stated “if funded correctly” (re the MEC) etc … however – you are “70 1/2” when forced to take distributions and be taxed on them … not “69 1/2” …. and of course if you fail to do THAT there is a 50% penalty … (most people do not know that …. ) Thank you for sharing !

    • Michael says:

      You are absolutely correct, Denise. The age for required minimum distributions from qualified accounts is 70 1/2. Thanks for the correction!

  4. Denise says:

    And by ‘forced’ at 70 1/2 I’m referring to the 401k’s IRA’s et … *NOT* the Indexed Universal Life …. Great Great Article !

    • Michael says:

      Of course and thanks. IUL’s (indexed universal life insurance policies) are extremely versatile financial tools. While it’s true that part of the premium goes toward the life insurance, so not as much goes toward the cash value (compared to a qualified plan); the flexibility of the premiums, the continuous income protection for your family, the instant tax-free estate if something happens, the zero or low-cost access to the cash value at any time using policy loans, the indexed growth of the cash value (so your value goes up when the market goes up but stays the same when the market goes down), the ability to grow a tax-free retirement income that cannot be outlived,, plus the opportunity to add other riders that provide other kinds of protection, make IUL’s a very valuable tool. Sadly, life insurance is greatly underutilized by many people, but especially women.

  5. Stephen says:

    Cash value insurance is NOT an investment. As a matter of fact I believe some years ago a class action lawsuit was awarded for insurance companies making that very claim.

    What you failed to mention was that the cash value of the policy belongs to the insurance company. Cash values are in place in case the policy is surrendered early. You get the money tax free because its a loan from the actual owners of the cash value, the insurance company. If I buy a 250K policy and in 20 years it has a cash value of 100K, then I die. Guess who keeps the 100K? The insurance company.

    People need to realize that insurance companies are investing your money in the same markets they try to scare people away from. They know its better long term to invest there, yet want people to fear the market. Its crazy and a bit shady if you ask me.

    You could probably argue a hypothetical situation where a cash value policy is worth buying, but to present it as a better alternative than 401K is irresponsible.

    The long term ROI for a “qualified” account is much greater than a cash value policy.

    • Michael says:

      Thank you for your comment, Stephen. For people who have no need for life insurance, you may be right. The premiums paid for an IUL includes the cost of life insurance. However, that doesn’t mean that an IUL is not the superior financial tool for many people. In a bull market for stocks, the upside potential of a 401(k) will be greater, but when you consider all the facts for most people, “that dog won’t hunt!” The math simply doesn’t work and I’ve addressed most of this in the articles on this site, but here’s an outline –

      Let’s review, in a 401(k), a worker gets an immediate tax deduction, their money is invested in a handful of options that are usually mutual funds, the value of the investment can go up or down because it is directly involved in the market, then you pay regular income taxes on the entire amount as you withdraw it. Generally, if you make withdrawals before age 59 1/2, you have to pay income taxes and penalties. The fees for management of the 401(k) can range up to 4% per year regardless of performance, and there are fees involved in everything that happens inside the various mutual funds, most of which the worker is never told, but which lower the rate of return. It is also true that MANY people that have retired or neared retirement in the last 8 years had their savings devastated by losses in the market. Have I got anything wrong so far? Here’s the most important thing to know about “qualified” retirement plans – they were invented as a way to promote investment in the stock market and the companies that manage these accounts always benefit, regarless of whether or not the worker does. These “qualified ” plans have replaced pensions, which provided a guaranteed income for life and were MUCH better for workers.

      In an indexed universal life insurance policy (IUL), premiums are paid to cover the cost of life insurance and to “overfund” the cash value, which grows based on the performance of a key stock index, frequently the S&P 500. The growth of the cash value can NEVER go down due to market forces, because there is a “floor” of 0 – 2%, depending on the company and product. To pay for the floor, insurance companies put a “cap” on the upside performance. For example, one company might say that if the market goes up 15%, you will only get 12% of the growth that year. To understand this, imagine a blackjack table in Las Vegas where you get to keep most of the winnings when you win, but also get to keep your entire bet when you lose! Over time, your cash value can ONLY go up, never down. How long would you sit at that table?

      On the “downside”, the premiums paid into an IUL are NOT tax deductible. HOWEVER, the gains grow tax deferred and then, when you retire (or at any time you have a need and have enough cash value available), you can withdraw money from the cash value without liability for income taxes by using zero or low-cost policy loans. If you do the math, you will see that the benefit of the initial deduction for deposits in a 401(k) or IRA are quickly eaten up in retirement, when compared to the tax-free income provided by an IUL. And please note: the policy loans do not need to be paid back, unliike borrowing money from a 401(k), which costs you 5% currently and must be repaid within 5 years. Policy loans can be repaid from the death benefit or the cash value, if the policy is surrendered. THIS FEATURE allows policy loans to be used to fund a college education, a new car purchase, a down payment for a home, virtually any emergency, without exposure to income taxes or penalties.

      Of course, if you don’t live a long life, an IUL also provides an instant tax-free estate for your family and heirs, to protect them from the loss of your earning power and to help them maintain their standard of living. What does the family of a guy with a 401(k) get if he dies too young? The amount saved and a tax bill!

      I know that there are many people who still cling to old and tired cliches about life insurance, but the purpose of this website is to try to expose the lies and misunderstandings. Please note that at NO POINT have I referred to the premiums in an IUL as an “investment.” Frankly, when I look at people getting raped by the rates paid by banks on savings and cd’s, or the rates paid by money market accounts, not to mention the fees paid to Wall Street firms even when they LOSE MONEY, it makes me sick! How the hell can they call that “investing?”

      But don’t take my word for it, read Patrick Kelly’s first two books – “Tax-Free Retirement” and “The Retirement Miracle”; and if you doubt my statement about where the “qualified” plans come from, read “The Great Wall Street Retirement Scam” by Rick Bueter. As for the fees paid for a 401(k), “60 Minutes” did a segment on TV that is shown on my site and, if you doubt any of this, let me know and I’ll document it for you. As for the idea that the cash value in a life policy “belongs” to the insurance company, that is somewhat true, but is functionally false. When you die, you normally get the death benefit only (normally, but not always). As described in the article on this site about the “Greatest Financial Tool”, I explained that the cash value in a whole life policy was created as a refund of the premiums paid. If you live long enough, the cash value equals the death benefit and the company refunds it to you. Your protection was free, so what’s your point? With an IUL, you get the opportunity to overfund the premiums and build a cash value that can fund a tax-free retirement income that you cannot outlive. Can a 401(k) guarantee that?

  6. Oscar B. says:

    If one wishes to pursue IUL for supplemental retirement savings & has existing 401(k) and IRAs from older jobs, what do you suggest? cash out theses plans & get hit with the taxes then invest in IUL’s??
    Thanks

    • Michael Goodman says:

      Cicumstances for every individual are different, but just cashing out of the other accounts and taking the tax and penalty hits are rarely warranted. Assuming an IUL is right for your situation (which can only be determined by exploring your situation in more depth), you would open the IUL and either fund it with some of the money you’ve been sending to the qualified plan, or fund the IUL with extra money you want to save. It depends on a number of factors, including your age, health, and what you’re trying to accomplish.

  7. Steve Ory says:

    I have been totally confused by someone who is explaining the IUL to me. Maybe I am too focused on how the companies can do what they claim.

    For one thing, how can they pay a death benefit of say 250K after the premiums stop coming in at 65? At age 70, would you get the 250K and the full value of the cash value part? Seems like the companies would loose a lot of money.

    • Michael Goodman says:

      It depends on how your account is set up and, yes, not every life insurance agent is an expert on IUL’s. Probably 1/2 the calls and emails I get come from other agents. Generally speaking, if you stop making premium payments at age 65, the payments will come from the cash value. Normally, by age 65, you’ve built up enough cash value that the annual growth in the cash value is more than enough to make the minimum premium payments. As to whether you would get the cash value plus the death benefit, that depends on how the account is set up. However, the ONLY time that both would be paid is at the death of the insured.

      You might find these two articles helpful –
      http://indexuniversallife.net/142/the-greatest-financial-tool/

      http://indexuniversallife.net/241/the-401k-versus-the-iul-part-two/

  8. Pingback: The 401(k) Versus the IUL (Part One) | Using Indexed Universal Life (IUL), Indexed Annuities, and Superior Planning to Increase Your Retirement Income

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