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When creating your personal retirement plan, there are a variety of tools you can use to fund your long-term savings goals. An employer-sponsored 401(k) is one of them while indexed universal life insurance (IUL) is another. A 401(k) allows you to invest money on a tax-deferred basis while also enjoying a tax deduction for contributions. Indexed universal life insurance allows you to secure a death benefit for your loved ones while accumulating cash value that you can borrow against. Understanding the differences and similarities between IUL vs. 401(k) matters for effective retirement planning. Working with a financial advisor can also make a substantial difference in the amount of money you’ll have when you retire.
What Is Indexed Universal Life Insurance?
Indexed universal life insurance is a type of permanent life insurance coverage. When you buy a policy, you’re covered for the rest of your natural life as long as your premiums are paid. When you pass away, the policy pays out a death benefit to your beneficiaries.
During your lifetime, an IUL insurance policy can accumulate cash value. Part of the premiums you pay are allocated to a cash-value account. That account tracks the performance of an underlying stock index, such as the Nasdaq or S&P 500 Composite Price Index. As the index moves up or down, the insurance company credits the cash value portion of your policy each year with interest.
IUL is different from fixed universal life insurance or variable universal life insurance. With fixed universal life insurance your rate of return is guaranteed, making it the least risky of the three. With variable universal life insurance, your cash value account is invested in mutual funds and other securities so you’re exposed to more risk. An indexed universal life insurance policy fits in the middle of the risk spectrum.
Cash value that accumulates inside an IUL insurance policy grows tax-deferred. You can borrow against this cash value if necessary, though any loans left unpaid at the time you pass away are deducted from the death benefit.
What Is a 401(k)?
A 401(k) is a type of qualified retirement plan that allows you to set money aside for retirement on a tax-advantaged basis. Contributions are deducted from your paychecks via a salary deferral. Your employer can also offer a matching contribution. The IRS limits the amount you can and your employer can contribute each year.
With a traditional 401(k), contributions are made using pre-tax dollars. Any money you contribute is automatically deducted from your taxable income from the year. When you begin taking money out of your 401(k) in retirement, you’ll pay ordinary income tax on withdrawals. Any withdrawals made before age 59.5 may be subject to a 10% early withdrawal penalty as well as income tax.
Traditional 401(k) plans allow you to invest in a variety of securities, including mutual funds and exchange-traded funds. Target-date funds are also a popular option. These funds automatically adjust your asset allocation based on your target retirement date.
There’s no death benefit component with a 401(k). This is money you save during your working years that you can tap into in retirement. Unless you’re still working with the same employer, you’re required to begin taking minimum distributions from a 401(k) beginning at age 72. Failing to do so can trigger a tax penalty equivalent to 50% of the amount you were required to withdraw.
IUL vs. 401(k): Which Is Better for Retirement Savings?
Indexed universal life insurance and 401(k) plans can both be used as investment tools for retirement. But there are some important differences to note. With IUL, returns are tied to the performance of an underlying index. If the index performs well, then your policy earns a higher interest rate. If the index underperforms, on the other hand, your returns may shrink. Your insurance company can also cap the rate of return credited to your account each year, regardless of how well the underlying index does. For instance, you may have a cap rate of 3% or 4% annually.
In a 401(k) plan, you have the option to invest in index mutual funds or ETFs but you’re not locked in to just those investments. You can also choose actively managed funds, target-date funds and other securities, based on your time frame for investing, goals and risk tolerance. Your rate of return is still tied to how well those investments perform but there’s no cap. So, if you invest in an index fund that goes up by 20%, you’ll see that reflected in your 401(k) balance.
A 401(k) also affords the advantage of an employer matching contribution. This is essentially free money you can use to grow retirement wealth. With an indexed universal life insurance policy, you’re responsible for paying all of the premium costs.
Another big difference between the two centers on tax treatment and withdrawals. With an indexed universal life insurance policy, you can borrow against the cash value at any time. You’ll pay no capital gains tax on loans and no penalties unless you surrender the policy completely or fail to repay what you borrow. Death benefits pass to your beneficiaries tax-free.
With a 401(k), you generally can’t tap into this money penalty-free before the age of 59.5, even in the case of a hardship withdrawal. You may be able to avoid a tax penalty if you’re withdrawing money for qualified medical expenses but you’d still owe income tax on the distribution. You could take out a 401(k) loan instead but that also has tax implications. If you separate from your employer with an outstanding loan balance and fail to repay the loan in full, the entire amount can be treated as a taxable distribution.
Qualified distributions in retirement are taxable at your regular income tax rate. And if you pass away with a balance in your 401(k), the beneficiary who inherits the money will have to pay taxes on it. Talking with a tax professional or your financial advisor can help you come up with a plan for managing tax liability efficiently both prior to retirement and after.
The Bottom Line
Indexed universal life insurance and a 401(k) plan can both help you build wealth for retirement but they aren’t necessarily interchangeable. If you have a 401(k) at work, this may be the first place to start when creating a retirement savings plan. You can then decide if IUL or another type of life insurance is needed to supplement your workplace savings as well as the money you’re investing an IRA or brokerage account.
Tips for Investing
- When using a 401(k) to invest for retirement, pay close attention to fees. This includes the fees charged by the plan itself as well as the fees associated with individual investments. If a mutual fund has a higher expense ratio, for instance, consider whether that cost is justified by a consistently higher rate of return.
- Consider talking with a financial advisor about how to maximize your 401(k) plan at work and whether indexed universal life insurance is something you need. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool makes it easy to get personalized recommendations for professionals in your local area in just minutes. If you’re ready, get started now.
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I don’t like to make generalizations too often, but I do feel that everyone over 30 should start thinking about the importance of life insurance. That is, if you’re 30 and over and don’t have any life insurance.
No one likes to think about their demise, but life insurance is an extraordinary product that can be used to reduce the financial burden you could leave behind for loved ones. Plus, different types of life insurance can even help you build wealth and diversify your assets.
Here are 4 important reasons why everyone over 30 should start thinking about life insurance.
The Insurance At Your Job is Probably Not Cutting It
By now you probably realize the life insurance coverage that your job offers is not enough. Some employers include life insurance in their list of benefits which is great, but the coverage amount often doesn’t come close to your insurable need.
Your insurable need represents how much life insurance you should hold depending on factors like your age, liabilities, health conditions, and so on. One common rule of thumb is that your average life insurance coverage amount should be 7 to 10 times your annual income.
So if you’re earning $60,000 per year, you might want to consider a policy of $420,000 to $600,000 depending on your needs. However, the average employee life insurance policy amount is only around $25,000 to $50,000 or one years’ salary. This is not nearly enough.
Plus, when you leave your job, you’ll lose your insurance benefits too. This is why it’s always important to consider having your own life insurance coverage independent of your employer. So many people are switching jobs every 2 to 3 years so you may not want your life insurance benefits to be tied to your employer anyway.
Term life insurance is pretty affordable and you can get a free quote in just a few minutes from Bestow.
Here are 4 important reasons why everyone over 30 should start thinking about life insurance. Click To Tweet
You Want to Protect Loved Ones From a Financial Burden
You don’t have to be married with kids and a house to want to consider life insurance. However, more people in their 30s do focus on settling down and working toward some of these milestones.
If you do have kids, a mortgage, etc. you’ll definitely want to consider how your partner would get by if anything did happen to you. Would the kids still be able to go to college? Would your spouse be able to keep the house? These are important questions that life insurance can help you answer.
Even if you’re single and at the height of your career. More people in their 30s are carrying debt like student loans and personal loans. Did you know that some types of student loan debt can not be forgiven even if you died? You probably don’t want to pass on any financial burdens to your parents or other loved ones who would have to fit the bill.
Life insurance provides a tax-free payment to your beneficiary which can help cover everything from debt payments, loss of household income, funeral arrangements, and more.
RELATED: How Much Life Insurance Do You Really Need
30 Is Still Young Enough to Lock in Affordable Rates For Whole Life Insurance
Let’s say you’re considering the importance of life insurance. Whole life insurance in particular. Whole life insurance is permanent insurance that builds cash value as you continue to pay your premiums.
Other types of insurance, like variable whole life, even allow you to invest some of the cash value and grow the amount faster. You can borrow from your cash value, use it to pay your life insurance premiums, or even withdraw it while you’re still alive and well.
While whole life insurance is cheaper than term life, costs increase around the board as you get older. If you’re considering whole life insurance, the best option is to get a policy while you’re younger. Thirty years old is not too old to still get a decent rate for your life insurance premiums. Plus, it allows you enough time to build cash value that could be put to use in the future.
Get Insured and Protected From Medical Issues
Yes, life insurance is geared toward providing financial relief for your loved ones. Depending on your policy, you may be able to obtain something called ‘living benefits’. Living benefits are an insurance rider (which means it’s an added on feature) that can be added to your term or whole life insurance policy.
Living benefits can allow you to use some of your life insurance coverage amount to pay medical expenses for a serious illness or condition. Of course, this will reduce the benefit provided to your beneficiary, but it can still be a helpful feature to help you cover medical bills that could otherwise be left for your loved ones to deal with anyway.
No one likes to think about getting sick or becoming terminally ill, but planning for the best and worst is just a part of adult life. As you get older, your health tends to decline but if you’re still healthy in your 30s, it’s the perfect time to lock in a life insurance policy and consider adding a living benefits rider.
RELATED: Should You Get Disability Insurance? 4 Ways to Decide
Life insurance should be apart of everyone’s financial plan. Knowing the importance of life insurance can be life-saving information. If you’re over 30 and still don’t have coverage. Consider all the reasons to get a term or whole life policy. Consider your current future needs and carefully weigh the pros and cons.
Remember, you can get a free no-obligation quote from Bestow in just two minutes.
The relationship between life insurance and the African American community is complex. Although Black Americans are more likely to own life insurance than whites, a recent study shows, their coverage is often far less.
The sizable coverage gap between Black and white Americans has many causes, experts say, including the way life insurance was sold in the Black community and how discriminatory practices have impeded access to coverage.
Without adequate life insurance, families may find it difficult to protect and pass on assets to the next generation. It’s not always obvious how much life insurance is enough, but there are ways to calculate the right amount of coverage.
What is the life insurance coverage gap?
Black Americans typically have one-third of the coverage of their white counterparts, according to a 2020 study by Haven Life, an insurance company. Both groups had less than the recommended coverage amount outlined in the study of five to 10 times annual income. But Black respondents reported having life insurance equal to about a year’s income, compared with almost three years’ worth for whites.
Having the right amount of life insurance can help beneficiaries cover costs like living expenses or debts. And given the COVID-19 pandemic, this safety net perhaps feels all the more necessary.
But historically, life insurance was often sold to African Americans as burial insurance — smaller, cheaper policies that cover the bare minimum. “Those door-to-door salesmen weren’t always truthful with them,” says Jessica Smith, an insurance agent in Marietta, Georgia, and clients weren’t told about other options.
Causes behind the coverage gap
After the Civil War, insurers began classifying Black people who were former slaves as higher mortality risks, meaning they were charged more or denied coverage altogether. These practices stretched into the 1960s, with separate sets of rates for Black and white applicants. Some states banned race-based underwriting, but many insurers simply took their business elsewhere, reducing access to coverage and segregating the industry.
For a long time, Black people were “excluded from the conversation of just protecting their assets and protecting their loved ones,” says Malcolm Ethridge, executive vice president and financial advisor with CIC Wealth.
Insurance companies would also find creative ways to not pay claims, Ethridge adds, “so then there became this level of mistrust between the Black community and the insurance world.”
Years of discriminatory policies also reduced access to medical care, housing and education for many Americans, and all these things can factor into the cost of life insurance.
If an applicant with a high school diploma, living in a poor neighborhood, applies for the same $2 million policy as someone with a Ph.D. living in an affluent neighborhood, the less educated applicant may get approved for coverage but will likely pay more for it, Ethridge says.
If premiums are too expensive, coverage becomes inaccessible, wealth may be harder to pass down, and the situation compounds.
Why the gap is a problem
The legacy of segregation, redlining and discriminatory policies has made accumulating generational wealth a challenge for many in the Black community, and the Haven Life study found that Black Americans are more likely than whites to think of life insurance as a way to pass down generational wealth.
This approach poses a problem when a person dies and is underinsured. In this case, assets that would have been passed down are often liquidated to pay for expenses, and less wealth is passed on, Ethridge says.
Getting the right amount of coverage
Many of these causes are the result of bigger historical and social issues, making it hard for policyholders to close the gap themselves. And being underinsured isn’t always easy to recognize.
If you’re not sure whether you have enough coverage, a financial advisor, insurance agent or online calculator can help you estimate how much life insurance you need.
“We first want to figure out what they want the life insurance funds to do for them once they’re gone,” Smith says. “Then we have to determine what amount of money they would need to achieve that goal.”
If people rely on you financially, you may want a large payout to support them for multiple years after you die. Alternatively, if you don’t have any financial obligations or dependents, you may not need coverage at all.
Though it’s increasingly legal, marijuana can still raise red flags for life insurance companies. While some insurers don’t mind covering you if you use pot, others will charge you higher rates or deny your application outright.
About 22.2 million Americans use marijuana every month, according to the Centers for Disease Control and Prevention. It’s now legal for medical use in 36 states and for recreational use in 15, as well as for both in Washington, D.C.
If you’re one of the millions of Americans who use marijuana and you’re looking for a life insurance policy, you can probably find coverage. You may need to shop around, however, as companies don’t view the risks that weed poses to long-term health in the same way.
Can marijuana users get life insurance?
In a word, yes, you can get life insurance if you use marijuana. In fact, life insurance may not cost more for some marijuana users than for those who don’t use it at all — depending on the insurance company and other factors.
Every insurer measures risk differently. Most consider factors like age, gender, weight and family health history. Some may look at your hobbies, such as mountain climbing or skydiving. Your history of drug use, whether marijuana or otherwise, can also come into play.
If you use marijuana, companies will likely consider how often and why you use it, according to Quotacy, a Minneapolis-based life insurance brokerage. If there’s a medical reason, the insurer will want to know about the condition you’re treating.
Because each company has different standards, you may need to research several insurers before you find one willing to cover you at a reasonable price. You can also work with a life insurance broker or agent who is experienced with marijuana use and can shop the market for you.
How do life insurance companies view marijuana use?
When applying for coverage, you’ll have to answer questions about your lifestyle and in many cases take a life insurance medical exam that may include drug testing.
“Keep in mind, if the application process includes a blood test, the marijuana usage might turn up in the results,” said Adam Weinberg, brand director for Haven Life Insurance, in an email.
Be sure to tell the truth about your use before taking your test. Lying on a life insurance application can result in an automatic decline for coverage. You also run the risk of your insurer refusing to pay your death benefit to your loved ones if it finds out later that you lied on your application.
When you apply for life insurance as a marijuana user, there are three potential outcomes:
You’re declined outright.
You’re approved at a tobacco rate, even if you don’t use tobacco. Rates for cigarette smokers and other tobacco users are typically several times higher than what a healthy applicant who doesn’t use tobacco might pay.
You’re approved at a non-tobacco rate.
While some studies have shown marijuana to be less harmful to the lungs than tobacco smoke, smoking is still smoking — meaning it’s less healthy than not smoking at all. And even if you don’t smoke but choose to vape or eat your weed, the jury is still out on how bad it is for you long-term.
“We don’t have a crystal-clear vision of how marijuana affects mortality because it has been illegal, so getting people to admit it — and doing the studies that an actuary needs — have been challenging,” says Jeremy Hallett, CEO of Quotacy.
How will marijuana use affect your rates?
When insurers decide whether to sell you a policy and how much to charge, they generally don’t consider whether marijuana is illegal where you live, Hallett says — but they do pay attention to how often you indulge. Occasional use of pot may not affect your rate much, if at all, while more frequent use could lead to higher premiums or even a denial.
Chris Abrams of Marijuana Life Insurance, an independent agency in San Diego, provided sample rates to show how typical marijuana habits can affect monthly insurance premiums. Abrams’ hypothetical applicant is a 30-year-old man, in excellent health, applying for a $500,000, 30-year term life policy.
Never uses marijuana: $30 a month.
Twice a year: $31.
Once or twice a week: $55.
Two to three times a week: $62.
Four times a week: $126.
Six times a week: $166.
The breaking point appears to be more than six times per week for recreational users. Very few insurance carriers will offer standard, non-tobacco rates to daily pot users, according to Hallett.
For most companies, Abrams says, “daily use is a ‘decline.'”
Does using marijuana mean you’ll lose your life insurance?
If you already have life insurance and you decide to give marijuana a try, don’t worry — it won’t affect an existing policy.
“Once you’re underwritten at a point in time for your insurance, that is your rate,” Hallett says. “The carrier can’t come back and raise your rates. You’re good to go.”
For people seeking financial security in case of an untimely death, there are two main types of life insurance: term and permanent. The truth is, however, most people don’t need permanent life insurance.
You might assume permanent life insurance is the better choice because it never expires, as long as you pay your premiums. Perhaps that’s why most buyers end up with a permanent policy. The 2020 Insurance Barometer Study by LIMRA, a life insurance trade group, found 51% of policyholders have permanent coverage only, while 33% have term coverage only.
If you’re looking into a plan for yourself, don’t get swayed by those numbers. Term life insurance, particularly for young, healthy people, is more affordable and less complex than permanent life insurance.
There are some situations where permanent life insurance is the right choice. But those cases are few compared with the typical need for life insurance.
Comparing the options: Term vs. permanent life insurance
If people in your life would suffer financially if you suddenly died, life insurance is a worthy investment. The death benefit that insurers pay out upon your death can cover debts, replace your lost income or help pay for your children’s education.
There are various types of both term and permanent life insurance, but the broad strokes of the two main buckets are as follows:
Term life insurance covers a set number of years. Once the plan expires, so does your death benefit, so this policy pays out only if you die while your plan is active.
Permanent life insurance lasts for the rest of your life. These policies also typically act as an investment vehicle — as you pay your premium, your plan accrues a “cash value” that you can borrow against or pull money out of.
Permanent life insurance: pros and cons
Permanent life insurance is your best option if the money from it will be needed no matter when you die. For example, if you know you’ll have lifelong dependents, such as a child with a disability, or want to help your heirs pay hefty inheritance or estate taxes or even funeral costs, a permanent life insurance policy is probably the way to go.
But there are drawbacks:
Permanent life insurance is much more expensive than term life. Whole life, the most common type of permanent coverage, can cost 10 to 18 times more than 20-year term coverage for a healthy applicant buying a $500,000 policy, a comparison of average life insurance rates shows.
The higher price means you may not be able to afford enough permanent coverage to meet your family’s needs. And if you choose permanent life insurance but later find you can’t keep up with the monthly premiums, your policy may lapse and you’ll run the risk of having no coverage when you die.
Permanent life insurance is often more complex than term life due to its investment component. And while your policy may build cash value, insurance can be an expensive way to save for retirement. The cost of the insurance is a drag on your investment performance, so you should consider other options first.
“It’s especially important for young people to take advantage of IRAs, Roths and traditional 401(k)s,” says James Hunt, a life insurance actuary who advises the Consumer Federation of America. “Don’t buy whole life insurance unless you have plenty left over after maxing out your IRAs.”
The benefits of choosing term life insurance instead
Many people will “outgrow” the need for life insurance as they put away savings, pay off their debts and finish raising their kids. That’s what makes term life insurance compelling: It can cover you for the years you need it, and then you can reassess.
The lower cost of term life is always a benefit, but it’s especially important in volatile times such as a recession or pandemic, when you could easily lose your job and your ability to pay a high premium.
And while term life doesn’t have cash value, many policies now include “living benefits” that allow you to withdraw cash in certain circumstances, according to Jeff Root, founder of Rootfin, an insurance agency based in Austin, Texas.
With this option, “you can access the death benefit while you’re still alive and pay out if you have a cancer, heart attack, stroke or other qualifying events,” Root said in an email.
The point is for your policy not to pay out
If you outlive your term life insurance policy, that’s a good thing. As Root noted, “the goal is for term life insurance NOT to pay out — you don’t want to die early.”
All that being said, choose the life insurance plan that is best for you. You can compare quotes for term life insurance online, or speak to a trusted financial advisor to understand the costs of permanent life insurance if you decide that’s a better fit.