You maxed out your 401(k). You earn too much income to qualify for a Roth, or maybe your Roth is maxed out also.
You are seeking decent gains, no stock market risk and tax-free money for retirement.
What do you do?
Take a look at permanent life insurance for an excellent (albeit lesser talked about) retirement savings option.
The two most popular types of permanent life insurance are:
- Whole Life
- Indexed Universal Life (IUL)
Whole life leads the two with 35% of life insurance sales and IUL trails at 24%.
However, in 2018, IUL sales grew at record levels as consumers looked for protection from stock market instability.
Why Chose a Permanent Life Insurance Policy in the First Place?
Permanent life insurance offers several advantages over term life insurance.
First, it is the least expensive type of life insurance. It provides temporary coverage for a period of time called a term. Term lengths are 10-30 years for the most part.
However, term life insurance offers a death benefit only without the opportunity to accumulate cash.
Permanent life insurance provides lifetime protection. At some point, you know the money will transfer to your heirs.
Permanent life insurance has several other uses/benefits in addition to the death benefit:
- Estate Planning
- Living Benefits1
- Supplemental Retirement Income
- Tax Shelter
- Protection From Stock Market Risk
- College Funding
- Personal or Small Business Loans
1 This means money to use while you are still living to offset the cost of other expenses, like long term care or a serious health issue which may not be immediately life threatening.
How Does Whole Life Insurance Work?
Whole life insurance is just one of many types of permanent policies in the life insurance industry. It was the original life insurance before the industry looked for ways to create variety and options.
In a nutshell, whole life provides a death benefit and a cash value accumulation.
You can set a limit for the policy to mature (usually age 121) that’s well beyond most people’s lifespan.
The insurance company will pay the death benefit whenever the insured person passes on.
As long as you pay the premiums, it doesn’t expire like term insurance.
Can You Earn Money In Your Whole Life Contract?
The policy accumulates cash based on dividends declared by the insurance company.
Many companies have a 100+ year track record of paying dividends. Even though the track record of dividend payments is long; they are not guaranteed.
Whole life policies return 3-5% on average.
These policies may include guaranteed growth or death benefits.
However, these guarantees come at a cost; whole life is usually more expensive than an IUL.
How Does Indexed Universal Life Insurance Work?
An agent who understands how to use IULs will structure your policy nearly opposite to term life insurance.
For term policies, you want as much death benefit as possible for the least amount of premiums.
When you want to build an indexed universal life insurance properly, you want the highest premiums for the lowest death benefit.
Yes, that’s correct. The IRS limits how much you can contribute to your life insurance policy based on the death benefit amount.
The IRS limits the contributions because they are exceptionally generous with the tax treatment.
However, this isn’t a problem.
Want to save more money in an IUL?
Increase the life insurance death benefit, and the contribution limit increases right along with it.
How Does Money Grow In An IUL?
A big difference between an IUL and a whole life insurance policy is the way interest is credited to the policy.
As mentioned before, whole life policies gain when dividends are declared by the insurance company.
The interest credited to an IUL is based on an index, with the most popular index is the S&P 500.
Let’s say your IUL is using the S&P Index to credit interest.
This does not mean your money is in the S & P, but rather the life insurance company uses it as a gauge for how much interest to credit to your policy.
You receive the same return as the S&P, but with 2 significant differences:
- If the S&P index is positive for the year, you receive the same return, up to a cap. If the cap is 11% and the S & P returns 13%; you receive the cap (or 11%) on your policy.
- If the S&P index is negative for the year, you receive 0%. In years like 2008, when the S & P is negative 37%, you would receive 0% on your policy. We say, “0 is your hero” because it protects your principal in a down market.
Even though your gains may be capped, protecting your downside is even more critical.
Buffett’s Only Two Rules For Investing…
Rule No. 1: Never lose money. Rule No. 2: Never forget rule No.1 – Warren Buffett
Each insurance company offers different indices to choose from. Some indices are uncapped.
All companies offer a floor of 0% to protect your principal in a volatile market.
IUL’s earn a higher return than whole life insurance on average. Some years might be 0%, and some might be 15%.
Returns average between 5-9% over time in an IUL.
Benefits & Limitations of Each Type
Now, there is no definitive answer about which is better – whole life or indexed universal life. It will depend on your long term goals and other assets in your portfolio.
It’s always best to work with a knowledgeable insurance or financial expert to help you plan for the future, though, because they can help identify if it’s a good decision for you or not.
But, for the most part, there are certain advantages and disadvantages which stand, regardless of who you work with, or what policy you sign up for.
Pros of Whole Life
Whole life insurance is a simpler product to understand. There are fewer components and options to customize.
Whole life also has stable premiums.
When you take out a policy, what you pay today will be the same as what you pay in 15 years.
You can set it and forget it (although it’s smart to review your life insurance annually).
Whole life has more guarantees than IUL, but these guarantees come at a cost.
Cons of Whole Life Insurance
The cash value accumulation of whole life grows much slower.
The rate of return is relatively stable, although not guaranteed. It may take several years to build up much cash value in the policy.
The more guarantees in whole life equate to higher fees.
If cash value is your priority, IUL could be the better option for you.
Pros of Indexed Universal Life
Indexed universal life has a higher rate of return, on average.
This gives you the ability to do more things with it such as skip premium payments or take out a no-questions-asked loan.
IUL policies also offer more flexibility.
You can adjust premium payments after you take out the policy. So no matter what happens in life, you can work with your agent to make sure your life insurance will always be in force.
The expenses inside an IUL are usually lower than a whole life policy.
Correctly set up and funded, your IUL can reduce the risk of outliving your money in retirement. This might be the biggest advantage of all.
We never know what sorts of costs the future will bring nor how long we will live. The policy will provide longevity insurance or insurance against living too long.
Cons of Indexed Universal Life
An indexed universal life policy requires an agent with experience customizing them. This is not a product where one size fits most.
An IUL policy which isn’t carefully tailored to your needs may end up costing you more money than it’s worth and not function as intended.
The two major issues which plague the IUL are usually due to:
- The agent not designing the policy for maximum funding, or
- The insured does not pay the planned premiums
There are lots of misconceptions about the IUL on other websites.
This is due almost entirely to the two points mentioned above.
Here’s a quick reference guide on the advantages and disadvantages of each:
Which Is Really Better, Then?
If you were to guess the answer is “it depends,” you’d be right.
It depends on your goals, needs, funding, risk tolerance, other assets, etc.
- If you are more conservative and want guarantees, then a whole life policy might be better for you.
- If you are looking for maximum cash distributions in retirement, then an IUL could be better suited for you.
If you don’t need permanent life insurance, do yourself a favor and save money with a term policy.
Work with an experienced advisor to create a personal financial & insurance plan for your own unique situation.
Life insurance can be an excellent way to offset the market and tax risks of your other savings plans.