For many, the 401(k) plan is the default standard for retirement planning. According to the Bureau of Labor Statistics, 52% of private sector employees with access to an employer-sponsored retirement plan chose to participate in 2022.
But lately, creators on social media are pushing something else entirely: indexed universal life insurance (IUL).
“A lot of people are thinking about creative ways to save for retirement,” says Mindy Yu, a certified investment management analyst and director of investing at Betterment, based in New York. “This came up as a solution because, hey, you’re actually invested in the market and this … also provides life insurance coverage.”
But before cashing out your 401(k) for a life insurance policy, take a step back to read the fine print. When it comes to IUL versus a 401(k) plan, which one wins out?
What’s so special about the IUL?
An indexed universal life insurance policy is a type of permanent life insurance. This means that in addition to the death benefit, the policy also has a cash value component, funded through premiums paid, that can be accessed during your lifetime and grows tax-deferred.
How an IUL’s cash value grows makes it distinct: you pick which stock and bond indexes that you want it to mirror, such as the S&P 500, then your insurance company pays interest based on that index’s performance.
With the historical average stock market return around 10% annually, some social media creators say that’s why the cash value’s growth over time could be enough for retirement.
Realistically, however, market volatility means the return won’t always be 10%. Some years, it could be more, others less. And with an IUL, there’s a lot of fine print over how those market movements affect interest payments and your monthly premium.
“Some may have caps in terms of how much you can actually earn relative to the index,” says Yu. “Let’s say the S&P climbs 10% in a year, but you’re capped at 5%. That’s the max that you can have.”
The reverse could also be true — if the market does poorly, your cash value might be protected against the full loss.
In contrast, a 401(k) plan is an employer-sponsored retirement account that is fully invested in the market. No gains or losses are capped. One bonus of a 401(k) is that you can get free money if your employer provides a match based on your contribution amount.
However, because 401(k)s are meant to be invested over the long term, taking money out isn’t easy. Early 401(k) withdrawals before age 59½ for nonqualified reasons may be penalized and taxed.
Why use an IUL for retirement?
An IUL can offer earlier withdrawals compared with a 401(k). That’s where many social media creators see the dual benefits of an IUL: On top of financial support for their loved ones after they die, policyholders can tap into that cash value once they’ve accumulated enough, which could be much earlier than retirement age. Withdrawing contributions (though not the earnings) could even be tax-free.
“So it gives you more liquidity, and in moments that you have cash flow issues, you might be able to tap into that money and use it,” says Nadia Fernandez, a certified financial planner at Financial Finesse in Los Angeles.
But an IUL’s cash value can take 10 years to build up, and there are risks to treating it like a savings account, she says. Those tax-free withdrawals? That only applies to the premium portion of an IUL’s cash value, since those dollars were paid after tax. Anything more than that — for example, if you dip into any earnings — would be subject to income tax.
If you’re withdrawing from your cash value and the market has declined, it could potentially subtract from your death benefit, Yu says. You might also be required to pay more into your policy to cover any market losses and keep it active.
And if paying more to keep your policy active coincides with a moment where you’re having cash flow issues, you could face a hard choice. Fernandez warns that if your policy lapses, you could lose your entire investment.
That’s a stark difference to most traditional retirement plans, including the 401(k). With a 401(k), you choose how much you want to contribute (up to a set amount, every year). And if you’re short on cash, you can pause your contributions. But it doesn’t affect your entire investment.
“Life insurance policies do have the benefit of greater flexibility and no penalties with withdrawing funds,” says Yu. “However, this benefit is a moot point if you intend to use life insurance to fund retirement, since you shouldn’t use those savings until you’re in retirement anyway. If you find yourself needing to tap retirement savings early, that’s a signal to take a closer look at your near-term financial problems and build short-term solutions, like an emergency savings fund designed for unexpected expenses.”
‘Why IUL is a bad investment’
Despite recent social media hype, thousands of people still type “Why IUL is a bad investment” into search engines every month, looking for answers. In reality, Fernandez says, you can have both an IUL and a 401(k) — it all depends on your financial situation.
When it comes to retirement, she recommends considering a Roth IRA before an IUL. The Roth IRA is also funded with after-tax dollars, and you can withdraw your contributions, though not the earnings on them, tax-free at any time.
Fernandez adds that a Roth IRA may come with less fees than an IUL, where it’s common to see fees as high as 8% or more.
If you have money left over after maxing out your retirement accounts and any health savings accounts, she says, an IUL could be a possibility if you still want the benefits of tax-deferred growth. But it’s important to understand the complexities of an IUL, along with what will happen in good years and bad years, and how that could affect your premium.
And when it comes to retirement savings advice, particularly on social media, Fernandez says to consider the source.
“You want to make sure as much as possible you’re getting guidance and information from someone that doesn’t stand to profit from the choice you make.”