Indexed Universal Life (IUL) vs 401(k)
What Is an IUL?
An IUL is a type of permanent life insurance that is based on a stock market index. IULs allow people to invest directly into an equity index or a basket of stocks through the life insurance policy that they bought from the company.
When you buy a policy, you’re covered for the rest of your life. IULs are considered permanent because you can keep the policy until you die or surrender it. When you die, your beneficiaries will receive the death benefit.
IULs have no penalties for making early withdrawals and the cash value within the IUL policy grows tax-deferred.
IUL is different from fixed universal life insurance (FUL) and variable universal life insurance (VUL). IUL is not based on the premium amount that you pay, the premiums for IUL are guaranteed.
What Is 401(k)?
401(k) stands for Section 401 of the Internal Revenue Code, which governs employer-sponsored retirement plans in the United States.
It is a retirement savings plan that allows employees to save money for retirement. The money contributed to a 401(k) is not taxed until it is withdrawn. Employers can match a portion of employee contributions.
401(k) plans are available to employees of companies with more than 50 employees. Employees of smaller companies may be able to participate in a similar plan called a 403(b).
How Does IUL Work?
When you buy an IUL policy, you’re covered for the rest of your life. The IUL is a tax-advantaged investment product that offers a death benefit.
IULs allow you to invest in the stock market without having to worry about losing your entire investment if the value of your portfolio drops. IUL gains are not taxed since they grow within the life insurance policy.
You don’t have to worry about making early withdrawals from IUL policies. IULs also offer cash value growth that is tax-deferred. This means that you don’t have to pay taxes on any of the growth in your IUL policy until you withdraw the money.
IULs are not subject to required minimum distributions (RMDs). It also offers an additional cash value that can be borrowed if you’d like to use the money for other expenses.
How Does 401(k) Work?
When you contribute to a 401(k), your contributions are not taxed. That means that you don’t have to pay taxes on the money until you withdraw it from the account. Employers often match a portion of employee contributions, which can help employees save more for retirement.
You can contribute to your 401(k) through payroll deductions or automatic transfers from your bank account. Your retirement savings grow tax-deferred until you withdraw the money.
You can invest your 401(k) in stocks, bonds, mutual funds, ETFs, and money market funds.
Similarities IUL and 401(k)
Investment Tools for Retirement
IUL and 401(k) offer a variety of investment options, including stocks, bonds, and mutual funds. IULs and 401(k) plans often offer low-cost investments (like index funds), which can help your money grow faster.
Both IULs and 401(k)s are tax-deferred investments, meaning the money invested in them does not have to be paid taxes on the gains until it is withdrawn. This allows both to grow at a faster rate than if the money was taxed as it was earned.
Available to Employers
Both IULs and 401(k)s are available to employers with more than 50 employees. IUL policies are also available to employees of smaller companies through a similar plan called a 403(b).
Differences IUL and 401(k)
Many employers offer a matching contribution to their employees’ 401(k) plan. This means that the employer will match a certain percentage of what the employee contributes to the account. IUL policies do not offer a matching contribution.
IULs are not subject to required minimum distributions (RMDs). This means that you don’t have to take money out of your IUL policy each year, regardless of how old you are. 401(k)s are subject to RMDs, which require account holders to withdraw a certain amount of money from their account each year.
IUL policies offer a death benefit while 401(k) plans do not. IUL policies also come with an additional cash value that IUL account holders can borrow against if they would like to use the money for other expenditures.
Which Is Better?
The answer to this question largely depends on the individual. IULs and 401(k)s offer many of the same benefits, and each has its own unique advantages. It’s important to consider your needs and goals when deciding which is better for you.
If you are looking for a death benefit or want tax-advantaged growth, IULs are a great option. IUL policies offer cash value growth, which is tax-deferred until account holders withdraw the money.
IUL policies also come with an additional cash value that can be borrowed against in case you need to use the money for other expenses.
If you want more investment options or contribute to your retirement plan through payroll deductions, 401(k)s are a better choice. Employers often match a portion of employee contributions, which can help employees save more for retirement.
401(k) account holders can also invest in stocks, bonds, mutual funds, ETFs, and money market funds.
Whichever option you choose, it’s important to start saving for retirement as soon as possible. The earlier you save, the more time your money has to grow.
IULs and 401(k)s are both excellent options for retirement savings. IULs offer a death benefit, while 401(k)s do not.
IUL policies come with an additional cash value that can be borrowed against if you need the money for other expenses. 401(k)s offer more investment options than IULs, and employers often match a portion of employee contributions.
It’s important to consider your needs and goals when deciding which is better for you. Start saving for retirement as soon as possible – the earlier you save, the more time your money has to grow.
401(k) Plan | A Complete Beginner's Guide
The 401(k) retirement savings account got its name from the Revenue Act of 1978, where an addition to the Internal Revenue Services (IRS) code was added in section 401(k). Consequently, 401(k) does not stand for anything except for the section of IRS tax code it was created in.
Traditional 401(k) vs Roth 401(k)
There are two types of 401(k) plans: Traditional and Roth 401(k)s. The traditional 401(k), named after the relevant section of the IRS code, has been around since 1978. With this plan, any contributions you make to the 401(k) account will reduce your income taxes for that year and will be taxed when they are withdrawn. Roth 401(k)s, named after former senator William Roth of Delaware, were introduced in 2006. Unlike a traditional 401(k), all contributions are made with after-tax dollars and the funds in the Roth 401(k) account accrue tax free. Typically, employees can take advantage of both plans at the same time, which is recommended among financial advisors to maximize retirement savings. Because of the way the contribution limits work, it is possible to invest different amounts into each account, even year-to-year, so long as the total contribution does not exceed the set limit.
Contributing to Your 401(k) Retirement Plan
Contributing to a 401(k) plan is traditionally done through one’s employer. Typically, the employer will automatically enroll you in a 401(k) that you may contribute to at your discretion. If you are self-employed, you may enroll in a 401(k) plan through an online broker, such as TD Ameritrade. If your employer offers both types of 401(k) accounts, then you will most likely be able to contribute to either or both at your discretion. To reiterate, with a traditional 401(k), making a contribution reduces your income taxes for that year, saving you money in the short term, but the funds will be taxed when they are withdrawn. With a Roth 401(k), your contributions can be made only after taxation, which costs more in the short term, but the funds will be tax free when you withdraw them. Because of this, deciding which plan will benefit you more involves figuring out in what tax bracket you will be when you retire. If you expect to be in a lower tax bracket upon retirement, then a traditional 401(k) may help you more in the long term. You will be able to take advantage of the immediate tax break while your taxes are higher, while minimizing the portion taken out of your withdrawal once you move to a lower tax bracket. On the other hand, a Roth 401(k) may be more advantageous if you expect the opposite to be true. In that case, you can opt to bite the bullet on heavy taxation today, but avoid a higher tax burden if your tax bracket moves up. Check out this article from Forbes to see the IRS tax rate tables for 2020, but remember that they are subject to change. A smart move may be to hedge your bets and divide your contributions between the two types of IRAs. If your employer allows you to add funds to both a traditional and Roth 401(k), then doing so reduces the potential risks of each. In this case, you will also have the ability to decide what proportion of your income goes into each account, meaning that as you near retirement and have a clearer idea of what position you will be in, you can put more into one or the other. When you do decide which avenue to take, make sure to thoroughly evaluate your decision. Moving funds from one account to another, such as from a traditional to a Roth 401(k), is time consuming and expensive, if even possible. Likewise, transferring a 401(k) from one employer to another in the event of a job change is also tricky. You want to make sure that when you put money into your plan, it will be able to sit undisturbed for a very long time.
Pension vs 401(k)
Pensions are similar to a 401(k), but are a liability to a company. If an employer offers an employee a pension, it means that they are promising to pay out a set amount of money to the employee at the time of their retirement. There is typically no option to grow this amount, but it also does not require any financial investment from the employee. Pensions, also referred to as defined-benefit plans, are becoming increasingly rare because it puts the financial burden of offering a retirement fund for employees entirely on the employer. 401(k)s, which are also called defined-contribution plans, take some of the financial pressure off of an employer, while also allowing employees to potentially earn a larger retirement package than they would have with a pension.
How Much Should I Contribute to My 401(k)?
Most financial experts say you should contribute around 10%-15% of your monthly gross income to a retirement savings account, including but not limited to a 401(k). There are limits on how much you can contribute to it that are outlined in detail below. There are two methods of contributing funds to your 401(k). The main way of adding new funds to your account is to contribute a portion of your own income directly. This is usually done through automatic payroll withholding (i.e. the amount that you wish to contribute, counting all adjustments for taxation, is simply withheld when receiving payment and automatically put into a 401(k)). The system mandates that the majority of direct financial contributions will come from your own pocket. It is essential that, when making contributions, you consider the trajectory of the specific investments you are making to increase the likelihood of a positive return. The second method comes from deposits that an employer matches. Usually employers will match a deposit based on a set formula, such as 50 cents per dollar contributed by the employee. However, employers are only able to contribute to a traditional 401(k), not a Roth 401(k) plan. This is especially important to keep in mind if you want to utilize both types of plans. A key variable to keep in mind is that there are set limits for how much you can add to a 401(k) in a single year. For employees under 50 years of age, this amount is $19,500, as of 2020. For employees over 50 years of age, the amount is $25,000. If you have a traditional 401(k), you can also elect to make non-deductible after-tax contributions. The absolute limit, counting this choice and all employer contributions, is $57,000 for employees under 50, and $63,000 for those over 50 as of 2019.
Plan in Advance
401(k) Plan FAQs
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.