The thing we need to understand when it comes to options for retirement planning is that there are good options and then there are great options. The difference is in the solution that each of the options may or may not provide.
Certainly, any person planning for retirement wants to accumulate as much wealth as possible but they also want to pay as little taxes as possible. Most people also want to be able to access their retirement money earlier than planned if a financial emergency arises, but what about those penalties?
Let’s face it, the feds were doing us a great favor when they approved 401(k)s, IRAs, and Roth IRAs, but as usual, their hunger for tax money just couldn’t be ignored. In the article, we’ll take a look at the IUL vs Roth IRA to determine which product does the best job of helping you achieve the goals you’ll set for retirement planning.
What is a Roth IRA and How Will it Help Me?
A Roth IRA is an individual retirement account that consists of some tax benefits that can help the account owner accumulate wealth for retirement. Although it contains some similarities to the traditional IRA, there are some distinct differences between the two.
For example, the contributions you make to an IRA are tax-deductible for the year you make them, but with a Roth IRA, your contributions are not tax-deductible.
However, since your contributions in a Roth IRA are made with after-tax money, you will not have to pay taxes on that money when you begin to withdraw it as long as you wait until you are at least 59 ½ or older.
There are several very good reasons to consider a Roth IRA as a vehicle to accumulate wealth for retirement but then again, like most retirement products that are controlled by the federal government, there are some downsides that you really should consider:
- Contributions are Limited – For 2019 and 2020, the contribution limit for a Roth IRA is $6,000 unless you’re 50 or older, then you can contribute $7,000. Beware, however, this contribution limit applies to all of your traditional IRAs and your Roth IRA.
- Not Employer-Sponsored – If you decide to go with a Roth IRA, your employer cannot be involved in setting up your account or diverting a portion of your paycheck to the account on your behalf. Some banks will allow you to set up automatic transfers from your bank account to your Roth IRA but other than that it’s up to you to set up and fund your account each year.
- Income Limits – With a Roth IRA, there are income limits that can affect your ability to max out your contribution limit. In 2020, that income limit is $124,000 for singles and $196,000 for couples who file married filing jointly.
- Early Withdrawal Penalties – Although you can withdraw your contributions from your Roth IRA early (you already paid taxes) without a penalty you could be penalized if you dip into your earnings before age 59 ½.
There is good news however, there are no required minimum distribution rules with a Roth IRA and unlike a traditional IRA or 401(k) you can continue your contributions as long as you’d like.
What is an IUL and how will it help Me?
First things first. IUL is permanent life insurance (indexed universal life insurance) and the rules for using it for retirement planning are different than rules that apply to a Roth IRA or any other traditional investment product.
In fact, there really aren’t any rules other than not letting it become a Modified Endowment Contract which could really screw up your chances of a tax-free retirement income. Since an IUL is insurance, there must be a death benefit so right out of the gate it makes good financial sense because if you die the first year your beneficiary gets the death benefit. Not true with the Roth IRA.
Almost every drawback found in a Roth IRA is not found in an IUL policy. There are no limits on contributions and there is no maximum income to hold you back from contributing to your IUL.Here’s how an IUL works.
You set up a policy with an experienced and reputable insurance professional who keeps track of which carriers have the largest CAP and lowest FLOOR rates.
When you pay your premium, a portion of the payment covers your cost of life insurance and fees while the remainder is placed into a cash account.
When you first open your policy, you’ll have the option to link your cash account to one or more equity index accounts (you can ask your agent for advice) and then each year your cash account will be credited up to your CAP rate based on the performance of each index account (it’s like investing in the stock market without actually being in the stock market).
For example, if your index accounts earn 15% over the crediting period (typically a year) and your CAP rate is 12%, your cash account will be credited 12%.
If, however, the market tanks and your indices lose money, you won’t be hurt because your policy will have a FLOOR rate of 0% which means you cannot lose money because of your choice of equity indices.
As your account accumulates wealth over time, it does so on a tax-deferred basis. This means that you can borrow money from your cash account instead of taking withdrawals and you won’t pay taxes on the loans. If you don’t want to pay the loans back they will simply be deducted from the policy’s death benefit when you die. Your beneficiaries will then receive the balance of the death benefit tax-free.
As we stated in our opening paragraph, the IUL and Roth IRA are two very good options when it comes to retirement planning. But when it comes to solutions for your retirement planning goals, we feel that when you consider the IUL versus the Roth IRA, the IUL is the better option because it contains none of the drawbacks found in the Roth IRA, traditional IRA, or 401(k).
Frequently asked Questions
Why is IUL a better choice than Roth IRA?
Although the Roth IRA is a very good vehicle for retirement planning, the Fed does place some constraints on it that can impact your income during retirement years when you’ll need it the most.
Annual contributions are limited to $7,000
Not sponsored by your employer (no matching dollars)
Income limits that can impact if you can contribute at all
Early withdrawal penalty
Aren’t withdrawals from IUL taxable?
When you decide to begin taking withdrawals from your IUL policy, you should take them as loans because the IRS does not consider a loan as income and will therefore not charge personal income tax on your withdrawal. Many refer to this as “the power of zero,” a term penned by David McKnight in his book with the same term.
Don’t IUL policies have a Cap on how much you can earn?
Companies that offer IUL policies do place a Cap on the amount of interest they will credit your cash account (usually between 10% and 13%) but the Cap is offset by a Floor rate that completely mitigates the risk of losing money if or when the market takes a serious downturn.