3 Ways an IUL can offer more than a 401(k)
You might be wondering what’s better for your retirement—IULs vs. 401(k)s?
Let’s look at three ways a properly structured, maximum-funded IUL (which is the abbreviation for an Indexed Universal Life insurance policy—a financial vehicle that I also call an IUL LASER Fund) can outperform a 401(k).
IUL vs. 401(k): AFTER-TAX VS. PRE-TAX CONTRIBUTIONS
When thinking about IULs vs. 401(k)s, you first want to compare the way taxes impact the money you set aside in these vehicles.
As you may be aware, 401(k)s are designed exclusively for pre-tax money. In other words, the money you contribute to your 401(k) account goes directly from your paycheck to your account—it has not yet been taxed. When you withdraw money down the road, let’s say at age 65 when you retire, you’ll pay taxes on the money you take out of your 401(k).
Uncle Sam tells you this is prudent—he’s “saving” you money today, and you can just kick those taxes down the road until retirement, when you’ll be in a lower tax bracket!
But in my opinion, that sales pitch is akin to selling snake oil.
You’re not just deferring taxes, you’re procrastinating them…when was procrastination ever a good thing?
I’ve seen it time and time again in my nearly five decades as a financial strategist. Most Americans are NOT in lower tax brackets when they retire.
In fact, the financial services industry has had to admit that most people who accumulate any type of a respectable retirement nest egg are not in lower brackets when they retire; in reality, they’re in brackets that are as high or higher than they’ve ever been in—even if they have less income in retirement.
Why? Part of the problem is what I call the Deduction Reduction.
During retirement, you’re likely no longer contributing to accounts like IRAs, 401(k)s, 403(b)s, or 457s. Your children are grown, so you’re no longer getting child tax deductions. If you itemize on Schedule A but you’ve just paid off your mortgage, you can no longer deduct your mortgage interest. And you’re no longer working, so you’re no longer writing off business expenses.
Not only are your tax deductions likely to be limited in retirement, but tax rates are also likely to go up. (There’s that little habit Congress has of raising taxes to deal with our nation’s trillions of dollars in spending and debt.)
Let’s compare this to an IUL. With an IUL, you’re contributing after-tax dollars into your policy, where it can grow tax-free. You’re getting your taxes over and done with now in your current tax bracket.
When you eventually access money from your IUL during retirement, you’re not worried about the loss of tax deductions or even current tax rates. You already paid your taxes. You have peace of mind, enjoying tax-free income from your policy—and an income-tax-free transfer of wealth to your heirs when you pass away.
I often compare the pre-tax vs. after-tax issue to paying taxes on the seed or the harvest. Imagine you’re a farmer. Winter is about to give way to spring’s warmer days, and you’re getting ready to prepare your fields for the growing season.
As you look out across your acres, you can picture the seedlings that will take root. You can see summer’s sun radiating life into your emerging crops. You can even look ahead to the fall, when you’ll be harvesting your bounty.
When would you rather be taxed? Would you rather pay taxes on the front end, when you purchase your seed? Or would you like to wait until the harvest, when you’re selling your crops?
Now apply this same question to the issue of financial planning. Would you rather pay taxes on your earnings before you “plant” them in a financial vehicle to give them a chance to grow? Or would you prefer to pay taxes on your “harvest,” when you go to withdraw money for retirement or other ventures?
I recommend paying taxes on the seed.
IUL vs. 401(k): MARKET PROTECTION VS. MARKET RISK
Now let’s compare how market volatility impacts IULs vs 401(k)s.
Let’s start by looking at what happened during what I call the Lost Decade (2000- 2010). Between 2001 and 2003, the 9/11 tragedy and the dot-com bust destabilized the market, and millions of Americans lost 40% of their traditional retirement account values.
Let’s say you had a $1 million nest egg saved in 401(k)s in the year 2001. In three years, you would have seen it drop to $600,000. Then it would have taken four years to come back to break-even at $1 million.
During that same time period, many of our clients doubled their money using IULs, or what I refer to as IUL LASER Funds.
How? They were protected by a 0% floor, which means they did not lose money due to market volatility when the market went down—and they made money when it was going up.
A few years later, disaster struck with the 2008 market crash, causing millions of Americans to lose 40% of their account values yet again. It took another four years (until 2012) for many of them to come back to break-even.
Contrast that with our clients who had money in IULs at the time. Many of them tripled their money.
How can IULs offer safety during downturns? Through something called indexing. With indexing, your money can be LINKED TO the market, while not actually being IN the market.
This way, your IUL benefits from tax-free growth during the market’s up years, and it’s protected from loss due to market volatility during down years with that guaranteed 0% floor.
IUL vs. 401(k): ACCESSING YOUR MONEY ANY TIME—WITHOUT PENALTIES
Now what about penalties for IULs vs. 401(k)s?
Let’s say you’re in your 50s and you have a good chunk of money set aside in your 401(k). Life is clipping along, but then an emergency strikes. You have a major accident, incur medical debt, and find yourself unemployed for a year while you recover.
You need to access money from your 401(k) to cover the bills, the mortgage, the kids’ college tuition, and your medical care.
Not only will you pay taxes on the money you withdraw from your 401(k), but you’ll also pay a 10% early withdrawal penalty (a juicy little bite Uncle Sam takes for himself when folks withdraw money from their 401[k] before age 59 ½).
Suddenly your nest egg has become Uncle Sam’s breakfast.
But what if instead you had your money in an IUL? You could access the money needed to cover all your expenses, AND you wouldn’t have to pay any taxes on that income. What’s more, you wouldn’t have to pay any early withdrawal penalties.
Thanks to IRS codes, if you access money from your IUL the smart way (in the form of a loan), you can enjoy tax-free income at any time, any age, for just about any reason, without owing any income taxes or penalties.
WHY 401(k)S AREN’T THE BEST
A Time Magazine story, “Why It’s Time to Retire the 401(k),” says the 401(k) “is a lousy idea, a financial flop, a rotten repository for our retirement reserves.”
A Wall Street Journal article titled, “The Champions of the 401(k) Lament the Revolution They Started” explains that the 401(k) was meant to be a supplemental plan, but it ended up becoming the primary plan for most Americans. Why?
Employers have been increasingly moving away from defined benefit pensions to defined contributions—like a 401(k)—where the employer lets you define how much you want to contribute from each paycheck, and they might match that contribution up to a certain percent. If your 401(k) makes or loses money in the market, that ends up being your problem, not your employers’.
DALBAR says the average person who has money invested in the market in IRAs and 401(k)s is only earning 3.49%.
Contrast that with the predictable rates of return that IULs can provide, with historic average annual returns of 5% to 10%.
To summarize, my favorite financial vehicle, an IUL LASER Fund (also known as a properly structured, maximum-funded Indexed Universal Life policy), knocks the socks off traditional 401(k)s for several reasons:
- It eliminates the dangers of future higher taxes. With IULs, you get your taxes over and done with before contributing your money so you can enjoy tax-free income during retirement.
- IULs give you the upsides of the market without the downsides. When the market goes up, you gain, thanks to indexing. When the market goes down, you don’t lose, thanks to your 0% guaranteed floor.
- An IUL allows you to contribute larger amounts, as opposed to the annual contribution limits of 401(k)s (in 2023, the annual 401[k] contribution limit will be $22,500, and $30,000 for those age 50 and older).
- An IUL also allows you to access money at any age, at any time, tax-free—and without any penalties.
- An IUL allows you to transfer the money in your policy to your heirs income-tax-free via the death benefit when you pass on.
To explore how properly structured, maximum-funded IULs can make a difference in your financial future, I’ve got several resources for you.
WANT TO LEARN MORE?
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Elevate Your Financial Dimension – Find out how you can improve your Financial Dimension journey and seize the liquidity, safety, predictable rates of return, and tax advantages of an IUL. Explore the in-depth financial strategies and learn from real-life client experiences by claiming your free copy of “The LASER Fund” book at LASERFund.com. Just pay for shipping and handling, and we will send it to you, absolutely free.
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