Pros and Cons of Using an IUL Account for Retirement

Indexed universal life (IUL) insurance policies that combine a death benefit with a savings account have become popular with retirement savers looking to balance life insurance protection with growth. Part of the premium paid for one of these policies goes into a cash account that earns interest based on the performance of a stock market index rather than at a rate set by the insurance company. Policyholders can tap the cash account via tax-free loans or withdrawals and modify premiums they pay as well as the death benefit. However, these policies come with high fees, premiums that typically increase with age and, along with the chance of higher returns, the risk that the cash account will underperform.

If you want to put a retirement plan together, a financial advisor can help you get started.

What Is Indexed Universal Life Insurance?

IUL insurance offers both a death benefit and a cash value component. The cash value component of an IUL policy is linked to the performance of a specific market index, often the S&P 500. They also have a guaranteed minimum interest rate, which may be as high as 2%, but the floor is usually set at 0%.

By attaching performance to a stock market index, policyholders earn a higher return than they could with a type of cash value policy that has the interest rate set by the insurer. The minimum, at the same time, protects against loss if the market does poorly.

For retirement planning, IUL policies can be used to accumulate cash value that can be accessed through loans or withdrawals during retirement. This cash value grows tax-deferred, meaning you don’t pay taxes on the growth until you withdraw it. And because withdrawals are considered loans against the policy’s cash value, they are generally tax-free, providing a potential source of income in retirement.

Pros and Cons of Indexed Universal Life Insurance for Retirement

When considering an IUL as part of your retirement plan, it’s important to weigh the pros and cons. Here is an overview of each:

Pros	Cons
Potential for Market-Linked Growth One of the main advantages of using an IUL for retirement is the potential for cash value growth linked to the performance of a market index. This allows policyholders to benefit from market upswings while avoiding the full impact of market downturns, thanks to the policy’s guaranteed minimum interest rate.	Complexity and Costs IUL policies are usually complex and often come with higher costs compared to other retirement savings options. The fees associated with IULs, such as administrative fees, cost of insurance and surrender charges, can eat into the cash value, reducing overall return on investment.
Tax-Deferred Growth and Tax-Free Withdrawals The cash value in an IUL policy grows tax-deferred, meaning you don’t pay taxes on earnings until you make a withdrawal. Additionally, withdrawals from the cash value are typically considered loans, which are not taxed as income. This can provide a tax-efficient source of retirement income.	Impact on Death Benefit Taking loans or withdrawals from the cash value can reduce the death benefit, leaving less for your beneficiaries. If the loans are not repaid, the outstanding balance will be deducted from the death benefit, which could affect your overall estate planning goals.
Flexibility in Premium Payments An IUL policy holder can change the amount and timing of premium payments. This flexibility can be beneficial if your financial situation changes. However, it’s important to maintain enough cash value in the policy to cover the cost of insurance and other fees. Otherwise, the policyholder may be required to pay more to keep the policy in force.	Caps and Participation Rates The growth in the cash value component is often limited by caps and participation rates. A cap sets the maximum interest rate you can earn, regardless of how well the market performs, while the participation rate determines the percentage of the index’s performance that will be credited to your account. These limitations can reduce the growth of your cash value. For example, if the benchmark returns 8% and the participation rate is 50% the account will earn 4%.

How Indexed Universal Life Insurance Compares to Other Retirement Options

Indexed universal life insurance, or IUL, differs from traditional retirement accounts because it combines permanent life insurance with a cash value component tied in part to the performance of a market index. Here are several key differences to other retirement accounts for you to consider:

401(k) plans: A 401(k) is an employer-sponsored retirement plan that offers tax-deferred growth and, in some cases, employer matching contributions. Unlike IULs, 401(k) contributions are limited by annual caps, and withdrawals before age 59½ may incur penalties.
IRAs (individual retirement accounts): IRAs offer tax-deferred or tax-free growth (depending on whether you choose a traditional or Roth IRA) and provide a wide range of investment options. Like 401(k)s, IRAs have contribution limits and penalties for early withdrawals.
Roth IRAs: Roth IRAs provide tax-free growth and withdrawals, making them a popular choice for retirement savings. Contributions are made with after-tax dollars, and qualified withdrawals are tax-free.
Annuities: Annuities provide a lifetime income stream guaranteed by the insurance companies that sell them. They can be appealing for retirees looking for stable, predictable income. However, annuities often come with high fees and less flexibility than IULs.

When to Consider Indexed Universal Life Insurance

Indexed universal life insurance may be worth considering if you want permanent life insurance coverage and also value the ability to build cash value over time. It can be especially relevant for people who have already taken advantage of tax-advantaged retirement accounts and are looking for another long-term savings vehicle.

An IUL may also appeal to investors who want some exposure to market-linked growth without directly investing the policy’s cash value in stocks. Because returns are generally tied to an index and may include a floor that limits negative credited interest, the policy can offer more downside protection than direct stock investing, although caps and participation rates can also limit upside potential.

High-income earners may consider an IUL when contribution limits make it difficult to put more money into accounts such as IRAs or 401(k)s. The ability to access cash value through policy loans or withdrawals can add flexibility, but doing so can reduce the death benefit and may create tax consequences if the policy lapses.

An IUL can also make sense when estate planning or legacy goals are important, since the policy combines cash value accumulation with a death benefit. However, the costs and complexity can be significant, so it is generally most suitable for people who understand the tradeoffs and expect to keep the policy for many years.

Bottom Line

A couple comparing an IUL with other retirement savings options like 401(k)s and IRAs.

Indexed universal life insurance can provide permanent life insurance coverage, tax-deferred cash value growth and flexible access to funds, but it also comes with fees, policy complexity and limits on market-linked returns. For some people, especially those who have already maximized traditional retirement accounts, an IUL may serve as a supplemental planning tool. Comparing it with options such as 401(k)s, IRAs and Roth IRAs can help determine whether the added insurance features and costs fit your retirement strategy.

Tips for Retirement Planning

If you want to use an IUL account for retirement, a financial advisor help you determine how it fits into your plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you want to know whether you’re saving enough for retirement, SmartAsset’s calculator can help you get an estimate.