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Indexed Universal Life (IUL) vs. Annuity

Byline profile imageEdited by Chris Thompson
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It can be difficult to choose between an indexed universal life (IUL) insurance policy and an annuity. Both of these products have the potential to provide financial security and help you achieve your long-term goals, but the right one will depend on your unique financial situation. We’ll explore the key features of IUL and annuities below, giving you the tools to make a more informed decision.

You may also want to talk to a financial advisor to determine how these tools may be able to work for you.

How Annuities Work

An annuity is a financial contract between an individual and an insurance company that provides a series of payments in exchange for an upfront investment. These payments can be made periodically or in a lump sum, allowing the individual to receive a steady income stream, primarily during retirement.

There are three main types of annuities to consider:

  1. Fixed annuities offer a guaranteed income stream for a specified term or lifetime. The income is stable and based on a predetermined interest rate.
  2. Variable annuities are investment-based and come with the potential for higher returns, but they are also coupled with additional risks due to market fluctuations.
  3. Indexed annuities have income linked to the performance of a market index, offering potential gains along with protection from losses through a guaranteed minimum rate of return.

It’s important to note that fees and penalties for annuities vary depending on the specific product and insurance company. It is essential to read the fine print and consult with a financial advisor for a deeper understanding and assistance in choosing the right type of annuity for one’s needs.

How Indexed Universal Life (IUL) Insurance Works

Indexed Universal Life (IUL) vs. Annuity

Indexed universal life Insurance (IUL) is a permanent life insurance policy that combines a death benefit with an investment component. The cash value of an IUL policy grows based on the performance of a chosen market index, such as the S&P 500.

Premiums are paid into the policy, with a portion allocated to the cost of insurance and the rest is invested in the chosen index. The cash value can potentially grow, with a cap on potential gains and a guaranteed floor to minimize losses. This approach offers a balance between investment growth and protection from market downturns. However, your returns can be capped and you end up receiving less than you expect.

Keep in mind that IUL policies can come with various fees, including premium loads, sales charges and surrender charges. This can make getting an IUL more expensive than you may be willing to pay. These expenses can affect the policy’s cash value and growth potential.

How Do Annuities Compare to Indexed Universal Life Insurance?

While examining the differences between annuities and IUL policies, it’s evident that each option offers unique features and benefits, making the decision highly dependent on individual goals and circumstances. There also isn’t a guaranteed situation that one or the other will always work for your individual goals. However, here is how each stacks up against each other.

  • Tax Benefits: Annuities and IUL provide tax-deferred growth on investments, allowing the cash value to grow without being taxed until the funds are withdrawn. IUL death benefits, however, are exempt from income taxes. The tax benefits of both products can help you accumulate wealth over time while delaying tax liabilities. Tax rules can change over time and consulting with a financial advisor or tax professional is essential to ensure compliance.
  • Investment Options: When it comes to investment options, annuities offer more variety through fixed, variable and indexed categories. On the other hand, IUL policies focus on indexed-linked investments with protection from losses. The choice will rely on one’s preference for variability and risk tolerance.
  • Death Benefit: Uniquely, IUL policies provide a death benefit that is paid to beneficiaries tax-free. Annuities generally do not offer a death benefit unless a rider is purchased for an additional cost. Annuity products might have death benefits via riders, showcasing the need to thoroughly review the contract with a financial advisor.

Choosing Between an IUL and an Annuity

Indexed Universal Life (IUL) vs. Annuity

If you’re weighing an IUL vs. annuity, begin with what you want the money to do. If your priority is lifelong insurance protection with the potential to build tax-advantaged cash value, an indexed universal life policy may fit. If your top need is predictable, potentially guaranteed income you can’t outlive, an annuity is designed for that job.

IULs include costs of insurance, administrative charges, and surrender periods; policy performance illustrations are not guarantees. Annuities may have surrender charges, rider fees, and—especially in variable annuities, mortality and expense charges, fixed and fixed indexed annuities often embed costs in crediting terms. In all cases, guarantees rely on the insurer’s financial strength.

Both products offer tax-deferred growth. IUL withdrawals to basis are generally tax-free, and loans are typically tax-free if the policy stays in force and isn’t a modified endowment contract; MEC status can trigger taxable distributions and potential penalties. Annuity earnings are taxed as ordinary income when withdrawn and may face a 10% penalty before age 59½; qualified annuities must follow required minimum distribution rules.

You may want to choose an IUL if you need permanent life insurance, value legacy planning and are comfortable funding a long-term policy with moving parts. Choose an annuity if your priority is turning savings into dependable retirement income with clearer guarantees. A licensed financial advisor can model scenarios, compare carriers and align the product and features to your timeline, risk tolerance and liquidity needs.

Bottom Line

Ultimately, the decision between an indexed universal life insurance policy and an annuity boils down to individual circumstances, financial goals and risk tolerance. By examining the key features of each product, you will be better equipped to make an informed decision. Don’t forget to speak with a financial advisor who can provide personalized guidance, ensuring you make the best choice based on your unique situation. And remember, as your financial journey evolves over time, it is essential to reevaluate your plan periodically to make sure you’re still on track to reach your intended goals.

Tips for Buying Insurance Products

  • A financial advisor can help you fit insurance into your financial plans. 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’re in the market for life insurance, figuring out how much coverage you need is the first step to finding the right policy for you. SmartAsset’s life insurance calculator can help you estimate how much your family will need in the event that something happens to you.

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