Retirement and estate planning are crucial, but are you putting yourself and your family at risk of missing your long-term financial goals using the wrong retirement account?
Traditional and Roth individual retirement accounts (“IRAs”) have been mainstays of retirement planning for decades. Both types of IRAs provide important tax benefits, but each has limitations and restrictions that cause them to be inefficient for high- (and not-so-high) net-worth taxpayers. As a result, people have been turning to more sophisticated investment vehicles for their retirement and estate planning needs. IRAs are still widely used, but it might be time to consider whether more sophisticated tools may help achieve your retirement and estate planning goals.
What is an IUL & How Does it Work?
One investment vehicle gaining prominence among high-net-worth individuals for retirement and estate planning is the Indexed Universal Life policy (“IUL”). An IUL combines permanent life insurance coverage with a tax-free retirement investment account, giving the owners a “two-for-one” benefit. Policy owners choose how much their premiums will be and any extra cash paid goes into an investment account tied to indexes, such as the S&P 500.
As with all life insurance policies, IULs pay a death benefit upon the account owner’s death. What makes an IUL special is the investment account, which allows for flexible investments and the potential for higher returns by linking the cash account to a stock index-based option. This means that the better the index performs, the higher the owner’s cash value growth can be, providing an additional source of income during retirement or for other financial needs. Typically, when the policyholder dies, the proceeds from the death benefit and the investment account will not be subject to taxation.
Although the investment account is usually tied to a stock market index, IULs often come with protections against market downturns. Common features include no-loss guarantees related to the invested principal and minimum guaranteed interest rates. These features (and others depending on the policy terms) protect policyholders and their investments from stock market volatility.
Making Roth-Like Benefits Accessible to Everyone
IULs provide substantial tax advantages that are comparable to a Roth IRA. The indexed portion of the policy grows tax-free during the policyholder’s life. Typically, when the policy owner dies, the entire payment to the beneficiaries is treated as “death benefits” which are not taxable under the Internal Revenue Code. As such, the growth of the indexed investment account escapes tax-free, in the same way as the growth of a Roth IRA.
Unlike IULs, Roth IRAs come with significant barriers to entry that make them inaccessible for many Americans. In 2024, married couples are only eligible to contribute to a Roth IRA if their combined income is less than $240,000. If they qualify, their annual contribution is limited to just $7,000 (or $8,000 if they are over 50). Traditional-to-Roth conversions are a common end-around to avoid those limits. However, they are often tax-inefficient since they result in paying ordinary income taxes on contributions in the year of the conversion.
IULs have no high-income limitations and no annual maximum on contributions. As such, people can contribute as much regardless of their income level. That means policyholders can contribute amounts sufficient to meet their long-term financial goals without being limited.
It is no wonder that people have started referring to these policies as the “Roth of the Rich!”
Retirement & Estate Planning
In addition to providing death benefit protection and cash value growth, IUL can be used as a retirement savings account. One of the key benefits of IULs is the ability to access the funds in a tax-free manner.
Owners can often make withdrawals from the policy’s cash value portion without incurring taxes. Additionally, most policies give you the option to take a policy loan. The loan proceeds are not taxed and typically do not have to be repaid during the account owner’s life. Policy loans are a great way to access the policy’s cash value for liquidity needs without sacrificing the accumulation of wealth from the principal’s continued tax-free growth.
As such, policyholders can access their funds during or before retirement while continuing to accumulate a significant amount of wealth over their lifetime. This can provide a supplementary source of income, helping to ensure that you can maintain your desired lifestyle throughout your retirement years. With its unique features and benefits, IUL can help build a solid financial foundation for your retirement years.
Further, many high-net-worth individuals use indexed universal life policies as a core part of their estate planning. The death benefit amount can be used to help minimize the impact of taxes on your estate and maximize the wealth you pass on to your beneficiaries. This can be particularly important for individuals with large estates or those who wish to leave a lasting financial legacy for their loved ones. By incorporating IUL into your estate planning strategy, you can ensure that your wealth is preserved and passed on according to your wishes, providing financial security and peace of mind for your family and future generations.
Conclusion
An IUL is a sophisticated combined insurance and financial instrument that an increasing number of individuals are using to meet their retirement and estate planning needs. It makes the tax-free growth of a Roth account accessible to everyone regardless of income level. It also allows policy owners to save the amounts necessary for their long-term financial goals without capping the allowable contributions.
Tax professionals at Wilson Hand can help you determine whether you and your family would benefit from using an IUL and whether your current retirement accounts can be converted in a tax-efficient manner.
For questions, please email me at [email protected].