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IUL vs Roth IRA: What’s the Difference?

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Most people are aware that they should start putting aside money for retirement, but many hold it off because of the complexity of the task and the sheer number of investment options. However, the reality is that most people can’t count solely on social security benefits to fund a comfortable retirement, making it more important to save for the future. To prepare financially for your golden years, you may want to look into a Roth IRA or an Indexed Universal Life (IUL).

IUL policies are a type of life insurance that  also has the ability to grow a large cash value. On the other hand, Roth IRA contributions are made with after-tax dollars, which is why they are a particularly attractive alternative for young investors and those who expect higher earnings and tax rates in retirement. Doing a little homework will help you pick the best retirement fund for your needs. In this article, we’ll be reviewing the differences between an IUL vs Roth IRA.

What Is an Indexed Universal Life (IUL)?

IUL is a type of permanent life insurance that falls within the scope of universal life insurance. The premium you pay for this type of policy goes toward two things: the cash value component and the death benefit. It works like a savings account in that the cash value increases over time due to interest.

Payouts from IUL policies are dependent on the rise and fall of a stock market index, like the S&P 500 or NASDAQ 100. Once the cash value reaches a certain point or when you decide, you can begin making tax-free withdraws or loans to boost your retirement income. The tax-deferred cash value grows over time from a combination of a portion of your premiums paid and interest payments.  Because an IUL is intended for both life insurance and a savings vehicle, the owner’s age and health condition can impact the premiums.. However, if the policyholder passes away before their beneficiaries, the IUL’s death benefit is paid out to them tax-free. Nevertheless, purchasing an IUL limits your potential for profit while shielding you from market downturns thanks to its ceiling and floor on your policy’ cash value.

Advantages of IUL

IUL is a great option for people who want to take advantage of tax-free income in retirement, and the life insurance feature can meet the needs of practically everybody. Here are other benefits you should consider:

  • Downside protection: Understanding that the IUL’s cash value is protected from market loses. Get safer, better returns: If the indexes tied to your account do well over the policy’s crediting period, you could see impressive returns from your IUL insurance policy.
  • Permanent life Insurance: Your IUL’s life insurance coverage is reasonably priced and provides the protection you would have required regardless, so long as you don’t have any serious health conditions.
  • Tax-free cash flow: Compared to other common investment vehicles, the IUL is attractive since it allows policyholders to access their money tax-free via loans.
  • Flexibility/Access: Both your monthly payment and your death benefit can be modified as needed. Similarly, a policyholder can adjust their coverage and premium payments at any time during the policy’s duration. Moreover, the policy ensures withdrawals can be made with relative ease. You can borrow against the cash value you’ve accumulated in your IUL insurance policy without having to wait until retirement to do so, and you won’t be charged a penalty for withdrawing money from your policy early.

Disadvantages of IUL

Before deciding to save with an IUL, investors should think about the following potential downsides:

  1. Caps restrict how much you can make: Insurance companies set a cap rate on cash value accounts, so even if the index rises by 30% or more in a terrific year, the account will only grow by the cap rate. The typical range for cap rates on IUL products and insurance providers is 8-12%.
  2. Risks: Despite the potential upside, investing in an IUL linked to a stock index is not without its share of risks. Possible shifts in market conditions pose a threat. This means the policy’s performance may suffer if the index performs poorly. 
  3. Higher fees: When compared to other types of savings or investment vehicles, such as a Roth IRA, the fees associated with an IUL policy may seem excessive. However, the permanent life insurance coverage portion of an IUL policy is generally overlooked, and the cost of providing such coverage can rise steeply as policyholders age.
  4. Insurance Cost: Costs for term life insurance are guaranteed to remain constant during the policy’s duration. In comparison, the premium of whole life insurance and IUL policies can vary. Your actual policy cost will depend primarily on your age and current health.  

What Are Roth IRAs?

Roth IRAs work in a similar way to standard IRAs, with a few key distinctions.

Since contributions to a traditional IRA are made with pre-tax dollars, investors can immediately enjoy lower tax payments. Taxes are typically paid at a lower rate upon withdrawal of funds following retirement. On the contrary, the funds you use to finance your Roth IRA account are those that have already been subject to taxation, such as paychecks. Because of this, your Roth IRA payments are considered “after-tax.”

After five years, contributions to a Roth IRA are no longer taxed, and withdrawals can also be made tax-free. The annual contribution limit is $6,000. Those over 50 are eligible for a $1,000 “catch-up” contribution. With a single filer’s income of $138,000 and a married filer’s income of $214,000, the maximum amount that you can contribute begins to phase out. However, if your annual income is more than $138,000 as a single person or $214,000 as a married couple, you cannot make direct contributions to a Roth IRA.

When it comes to investing, the possibilities are endless with a Roth IRA because it is not connected to a certain employer. Roth IRAs can be retained for the rest of the account holder’s life, unlike standard IRAs, which must be distributed after they reach the age of 70.5.

Advantages of Roth IRAs

Roth IRAs have plenty of attractive benefits, which include the following:

  • Tax-free withdrawals: Because contributions to a Roth IRA are made using money that has already been taxed, distributions taken from the plan won’t be subject to income tax when the time comes.
  • No compulsory payouts: Required minimum distributions (RMDs) must be taken from a traditional IRA the year after the account holder turns 72, but from a Roth IRA, withdrawals aren’t obligatory.
  • No upper age limit: A Roth IRA allows you to continue making contributions indefinitely, but a standard IRA requires you to stop doing so once you reach age 70.5.
  • Only a few restrictions on withdrawals: A Roth IRA allows for tax-free withdrawals of contributions.

Disadvantages of Roth IRAs

There are a few potential drawbacks to Roth IRAs despite their many advantages:

  • No tax deductions: You can’t claim a tax deduction for your Roth IRA returns like you would be able to with a standard IRA because you’ve already incurred taxes when you paid your contributions.
  • Income-based caps: If you earn a lot of money, you may not be eligible for a Roth IRA because there are income restrictions depending on your modified adjusted gross income.
  • Limitations on taking out earnings: You need to be 59.5 years old or over and it must have been at least five years after you made your first contribution to a Roth IRA before you can take your earnings free from penalty.
  • Not all retirees will benefit from this: There is no guarantee that the tax-free withdrawals would be beneficial if you move into a lower tax bracket in retirement than the one you were in while working.

IUL Vs. Roth IRA: Final Thoughts

Depending on your age and financial situation, a Roth IRA or an IUL policy account can provide you with tax benefits and other perks.

Any investor can gain from a Roth IRA, but younger ones who anticipate higher earnings in the future and don’t need the tax deduction of investing with pre-tax funds may prefer a Roth IRA over a regular IRA. Income and investment restrictions exist, but the funds grow without taxes over time.

On the other hand, those who wish to hedge their retirement savings against market volatility may find IUL appealing. You are protected by an IUL’s caps and floors, and the death benefit can help their beneficiaries.

Regardless of whether you prefer an IUL or a Roth IRA, it’s crucial to have a mix of retirement investment/ savings vehicles to help you reach your financial objectives and meet your family’s needs. However, it can be difficult to strike a balance between different investment options in a retirement portfolio. 

We hope this article has provided you with useful information as you consider how to diversify your retirement funds.

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About the Author: Benjamin Hulburt

Benjamin Hulburt - Safe Wealth Plan