Preparing for retirement comes with decision paralysis because of the endless investment choices. How do you know which is the best option for you? Deciding between an IUL vs annuity can be confusing.
Both are financial products, but they serve different purposes. Learning the differences will help you determine the best investment for your retirement.
What is an IUL, and What is an Annuity?
An Indexed Universal Life (IUL) policy is a form of permanent life insurance. Its most attractive features are its death benefit and cash value component. The cash value grows based on a stock market index but doesn’t invest directly in the market.
What does this mean for you?
You can enjoy market gains without the risk of losing money when the market drops. Also, you can access the cash value through loans or withdrawals during your lifetime. If you cancel a policy, you can use the cash value.
An annuity, on the other hand, is a contract with an insurance company. Annuities give you a steady income stream, usually in retirement. There are different types of annuities:
- Fixed annuities guarantee a specific payout.
- Variable annuities allow investment in stocks and bonds, so payouts depend on that performance.
- Indexed annuities are linked to a stock market index like IULs but without life insurance benefits.
4 Key Differences Between an Annuity vs Indexed Universal Life Insurance
If you look closely at an annuity vs indexed universal life insurance, you’ll see some major differences. You and your financial advisor should consider these factors when comparing an IUL vs an annuity.
Purpose
An IUL provides life insurance with the added benefit of cash value growth. It offers both a death benefit for your loved ones and the potential for cash value accumulation based on stock market performance. A death benefit is the money paid to your beneficiaries when you pass away.
An annuity provides a steady income, usually during retirement. It ensures a reliable stream of payments for a fixed period or the rest of your life. Some annuities also provide a death benefit, but that depends on the contract. This death benefit may also come with extra fees.
Predictability and Growth
With an IUL, the cash value grows based on an index like the S&P 500. If the market does well, the cash value increases. Growth may slow if the market doesn’t perform, though the principal is often protected from loss.
An annuity, especially a fixed annuity, offers guaranteed payments. However, an IUL vs indexed annuity is a better comparison. Both options can give you growth linked to the market. Annuities give you predictable income, with less risk than an IUL.
Tax Treatment
You will pay IUL premiums with after-tax dollars, but the cash value grows tax-deferred. The death benefit is typically tax-free for your beneficiaries. Annuities also grow tax-deferred, but you pay taxes on the earnings when receiving payments.
Flexibility and Liquidity
An IUL offers more flexibility in withdrawals, loans, and adjustments to your premium payments over time. You can access your cash value with loans and withdrawals while still maintaining the death benefit. Cash value from an IUL also doesn’t hurt your Social Security benefits. The value accumulation won’t count as taxable income.
With an annuity, especially after the income phase begins, your payment schedule is fixed, giving you less flexibility. Early withdrawals often come with heavy penalties and fees. This makes your investment illiquid. Also, annuities are another income stream, so they are taxable which may affect your Social Security benefits.
Is an IUL an Annuity?
No, an IUL is not an annuity. Although both are financial products offered by insurance companies, they serve different purposes.
An IUL is primarily a life insurance policy. It provides a death benefit on cash value built over time based on the performance of a stock market index. The death benefit is a way to provide financial protection for your loved ones after you pass away.
On the other hand, an annuity is a financial contract that gives you guaranteed income, usually in retirement. It doesn’t typically offer a death benefit like a life insurance policy. Instead, you pay an insurance company a lump sum or regular payments.
You receive a steady income over a set period or for the rest of your life. Also, your money is tied up in a long-term commitment. Cancellation or withdrawals will come with heavy penalties.
At a glance, if you look at an IUL vs an index annuity, you might assume they’re the same. But they are different.
Annuity or IUL: Which is Right for You?
Deciding between an annuity or an IUL depends on your financial goals and what you need from your money.
For example, consider an IUL vs an index annuity. Let’s say you want both life insurance and investment growth. An IUL might be ideal, giving you a death benefit while your cash value grows based on a stock market index.
An index annuity could be a better fit if you’re closer to retirement, say age 60, and your main goal is income security. It provides guaranteed payments for life, with some potential growth tied to market performance.
When to Choose an IUL vs Annuity
An IUL vs annuity is better suited to you if:
- You want life insurance with the added benefit of cash value growth.
- You’re looking for flexibility in accessing your cash value.
- You want to leave a tax-free death benefit for your beneficiaries.
- You’re comfortable with some exposure to market performance for potential growth.
When to Choose an Annuity vs Annuity
An annuity vs an IUL is better suited to you if:
- You’re primarily concerned with securing a steady income stream, especially for retirement.
- You want to reduce risk and guarantee a predictable payout.
- You don’t need life insurance but want to ensure you won’t outlive your savings.
- You don’t mind less flexibility and illiquidity in exchange for guaranteed payments.
Build a Solid Financial Foundation
Regardless of your goals, you want your financial future to look bright. Work with the team at Asset Preservation Wealth and Tax to get a custom plan. Our professionals with with tax experts and lawyers to give you sound advice based on your goals. As fiduciaries, we’ll help you decide what best for you.
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Any comments regarding safe and secure investments and guaranteed income streams refer only to fixed insurance products. They do not refer in any way to securities or investment advisory products. Fixed insurance and annuity product guarantees are subject to the claims paying ability of the issuing company; not guaranteed by any bank or the FDIC.
Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
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