Indexed Universal Life Insurance as a ROTH IRA Alternative

By Larry Ottem on April 9th, 2012

 

THE CONCEPT:

There are many vehicles for people to generate retirement income.  IRAs are a common alternative.  A ROTH IRA has benefits of not only income tax deferral but also tax free income.  Of course a ROTH IRA has disadvantages including possibility of loss due to market performance (if using mutual funds), and limitations as to usage including contribution and income limits.  When using an indexed universal life policy, the cash value can be used to generate the benefits of a ROTH IRA and more.  The benefits of life insurance include a lack of client income tests on contribution limits.  For many life insurance can be a compelling option as an alternative or supplement to a ROTH IRA for generating retirement income.

SOLUTION:

An Indexed Universal Life insurance policy will ensure financial security and retirement if something were to happen before retirement.  An Indexed Universal Life insurance policy presents several additional benefits:

  • No funding limitation
  • Tax free income if taken via loans and policy remains in force
  • Life insurance provides leveraged remaining assets post retirement via death benefit
  • No early withdrawal penalties
  • Private and probate free
  • Competitive performance
  • Downside performance protection
  • Chronic Illness Accelerated Benefits

For the many people that are not allowed to fund a ROTH IRA, or contribute as much money as they'd like to one, an indexed universal life insurance policy can be a very attractive alternative.

There is a small but meaningful shift going on in the retirement savings world.  Most people don't think of life insurance as a potentially powerful part of a retirement plan.  For many people, a properly structured indexed universal life insurance policy can be an attractive ROTH IRA alternative and one of the best ways to prepare for a prosperous retirement.

ROTH IRAs are often suggested as a great retirement planning tool for a number of compelling reasons and indexed universal life policies can offer many similar attractions.

Most people know that ROTH investors don't get the tax deduction like when contributing to traditional IRAs.  But if you believe taxes will be much higher in the future than today, foregoing an initial tax deduction today on a smaller amount of money in return for tax-free retirement income (on a larger amount of money) in the future is a smart trade-off.  Plus ROTH IRAs don't have the annual required minimum distributions that start at age 70 ½ like traditional IRAs either.

But the problem for many is that they earn too much money to be allowed to fund a ROTH IRA.  Or even if people do qualify to contribute to a ROTH, the most they can contribute in any tax year is $5,000 - $6,000 depending on if they are age 50 or older.

This is how an indexed universal life insurance policy fits into a situation where tax-free retirement income and funding flexibility is desired.

When properly structured, the cash accumulation in a cash-value life insurance policy can be accessed through policy loans or withdrawals on a tax free basis under tax law that's been in place for decades.  Index universal life insurance may be the fastest growing type of universal life insurance because cash in the policy is credited interest based on stock or bond market index performance with no risk of declines.

Most indexed universal life insurance (IUL) policies credit interest based on the performance of the S&P 500 index (or some other major market index or indexes) subject to a cap on annual crediting (usually between 11-15%) as well as a floor of interest credits (usually 0%-2%) when the index itself has a negative performance.  So when the index performs positively but below the cap, the cash in the policy will be credited with that same amount of interest.  If the index performs better than the cap, the policy would be credited with the interest amount subject to the cap.  In years when the index is negative, the policy would be credited with the "floor" amount of interest but the cash accumulation does not go backwards due to the negative performance.

Another reason for the shift towards life insurance is, just like ROTH IRAs, there are no minimum required distributions with an indexed universal life insurance policy.  More importantly, the biggest reason why these policies make attractive ROTH IRA alternatives is that anyone, regardless of their income level, can fund a policy to almost any amount of money that they'd like.  So for those who earn more than the ROTH income limits as well as those who don't want to be limited in their annual retirement funding, they can put $10,000-$100,000 or perhaps much more away for their retirement.

Of course, the index universal life policies come with a death benefit like all life insurance policies, but when structuring the policy for cash accumulation, we purposely minimize the death benefits to the lowest level the I.R.S allows to keep the policy mortality charges as low as possible.  However, should the insured die prematurely, the death benefit will be substantially greater than the cash in the policy which is another advantage of the life insurance policy over the ROTH.  Consider this "self-completing" as another big advantage of the retirement savings plan.

If you are just interested in temporary death benefit protection instead of cash accumulation, then a term insurance policy may be a better fit. 

And don't confuse index universal life insurance with indexed annuities as earnings from annuities are taxed as ordinary income, along with the fact that crediting caps on index annuities are generally much lower than on index universal life insurance.

Comments

Submitted by Jeremy Smith (not verified) on

At www.lifeinsurancethinktank.com we agree whole heartedly with your thoughts here and endorse your educational comments. For many people who cannot contribute to a Roth IRA, an IUL is probably one of the better choices to provide for additional sources of retirement income that is both tax-deferred and tax-free.
We also believe that it can be used in addition to a Roth IRA because of hte benefit of the life insurance protection for the heirs passing tax free. Keep up the great job!

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Dislcaimer

The information contained herein is for general information purposes only. Imeriti, Inc. is not to be held responsible for the accuracy of this information. Neither Imeriti, Inc. nor its employees provide tax or legal advice. As with all matters of a tax or legal nature, your clients should consult their own tax or legal counsel for advice. Any taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax adviser.