Life insurance is a valuable asset if properly utilized in a retirement income plan. But are you confident in which policy is best for you?
Comparing Life Insurance Policies
Two popular permanent insurance policies available are Whole Life policies, which yield a guaranteed fixed return, and Indexed Universal Life (IUL) policies, which allow for participation when the market goes up and principal protection if the market goes down.
These products may benefit those who wish to provide for their loved ones after they pass away as well as those who wish to accumulate cash value on some of the money paid into their life insurance policy. However, the key differences between these products makes each more attractive for people with differing needs. Determining which is better for you depends on your personal situation.
As you may already know, Indexed Universal Life (IUL) insurance is a type of permanent life insurance. Compared to a standard whole life insurance policy, where there is a given (and usually quite low) rate of return on the cash value, the indexed universal life insurance policy allows you to “earn” a market return on your cash value based on an index, thereby mimicking the performance of the overall stock market.
An IUL policy may be used to accumulate substantial retirement savings as well as provide for beneficiaries should the owner die prematurely. Because the money paid toward this product has already been taxed, withdrawals, and or loans, can be made tax-free. This tool benefits policyholders who wish to generate savings at a lower tax rate than they may encounter in the future.
As mentioned before, IUL policies mimic a specific stock index, such as the S&P 500, and provide returns based on market performance. Once the cash value has built up to a substantial level, the client can begin taking tax-free withdrawals/loans to supplement their retirement income.
With an IUL, only the premiums that are not used towards life insurance coverage are used to build tax-deferred cash value. And since an IUL is used for life insurance, as well as a cash accumulation tool, the owner’s age and overall health can have a huge impact on premium costs, which would ultimately hurt the accumulation. However, the added death benefit of the IUL, pays tax-free dollars to the designated beneficiaries should the owner die prematurely.
Although IULs can generate a considerable amount of cash value, this product must be well-funded by the owner in order for it to preform as intended. Allowing the policy to lapse can actually leave the policyholder with a large tax bill, so the owner should be advised that this is a long-term planning strategy with potentially significant penalties if the policy is surrendered or lapses.
A standard whole life policy has a level annual premium that must be paid each year for as long as the insured lives. Whole life insurance builds up an internal cash value that reduces the amount of death benefit the insurance company has at risk. If a policy is surrendered, the cash value would be paid out to the owner. A participating whole life policy can earn dividends or interest on top of the guaranteed cash value, based on the insurance company's results. The extra cash can be used to increase the death benefit or pay a part of the annual premium.
Cash values of a whole life policy can never regress, regardless of external market conditions. However these values accumulate at typically a much lower average rate than an IUL. Although the rate of return in an IUL may decrease over a number of years, there is usually a set limit, or floor, that the rate of return may drop to.
Which Life Insurance Policy is Best?
At face value, a whole life policy may seem like the best option since cash values of a whole life policy can never regress, regardless of external market conditions. But when looking at the potential rate of return, a whole life policy will generally accumulate at a rate of 3-4 percent, whereas an IUL will generally perform around 7 percent with a cap as high as 14%. Also, policy contributions and premium payments are flexible making them attractive for tax purposes because of its tax-deferred growth; cash value won't decrease if the target index falls. On the other hand, premium payments in a whole life policy are usually fixed and cannot change throughout the life of the policy.
Although a whole life policy may be better suited for conservative consumers who are looking for guaranteed returns, an IUL is best for those who wish to maximize their cash value growth potential.
Ultimately, a person who wants to purchase either of these products should consider all their options and seek the advise of an independent financial or insurance professional to decide which method is right for their personal situation.