Indexed Universal Life Insurance vs. Qualified Plans (401k/IRA/403b)

Life insurance isn’t a replacement for conventional retirement plans, but it does offer notable strategic benefits. By complementing a 401(k) with cash value life insurance, retirement savings can be boosted through tax-free withdrawals, protection from stock market volatility, and increased flexibility. 

In this article, we will compare indexed universal life policies—often utilized for tax-free wealth accumulation—with qualified plans such as 401(k)s, IRAs, and 403(b)s.

Quick Summary

Qualified plans are fantastic for taking advantage of employer contributions. They’re also easiest to find information about because they’re the most common forms of retirement savings strategies. 

In contrast, indexed universal life insurance is a less familiar strategy for creating a tax-free retirement income stream.

Table of Contents

• What is a qualified retirement plan?
  • Types of Qualified Retirement Plans
  • Benefits of qualified plans
  • Disadvantages of qualified retirement plan
  • What Are Non-Qualified Retirement Plans?
• Popular wealth-building strategies
• What is indexed universal life insurance?
  • How IUL accumulates cash value
  • How people use IUL as tax-free retirement income
  • Disadvantages of IUL
• Comparing different savings options
• How to increase your retirement income 60% to 100%
• Ultimately, what’s the best option?
• FAQs
• How Abrams Insurance Solutions can help

What is a Qualified Retirement Plan?

A qualified retirement plan is a structured savings program established by an employer to provide retirement income to employees and their beneficiaries. These types of plans are designed to meet specific criteria outlined in the Internal Revenue Code (IRC) and adhere to the guidelines set forth by the Employee Retirement Income Security Act (ERISA). 

The key characteristics that define a qualified retirement plan include its compliance with federal regulations regarding accountability, transparency, and equal access for all eligible employees.

Types Of Qualified Retirement Plans

Qualified retirement plans primarily fall into two categories: defined benefit and defined contribution. Additionally, there are hybrid options, like the cash balance plan. 

Defined benefit plans provide employees with an assured payout upon retirement, shifting the investment risk to the employer responsible for adequately saving and investing to fulfill the plan’s obligations. A traditional annuity-based pension is a classic example of a defined benefit plan. 

In contrast, defined contribution plans are structured so that the retirement income depends on the amounts employees choose to contribute and the success of those investments.

Employees typically can select their investment options and assume all associated risks. The 401(k) is a well-known example of a defined contribution plan.

Other examples of qualified plans include 403(b) plans, pension plans, profit-sharing plans, and Employee stock ownership plans (ESOPs)

Employers managing qualified retirement plans have specific responsibilities. They must ensure that the plans are operated according to the established guidelines and provide clear information to plan participants about their benefits.

Furthermore, employers must be vigilant in keeping up with changes in retirement plan laws and regulations to maintain the qualified status of their plans. This commitment not only protects the interests of employees but also ensures that both employers and employees can fully benefit from the tax advantages associated with qualified retirement plans.

Benefits of Qualified Plans

Tax Advantages

One of the most significant benefits of qualified plans is their tax advantages. Contributions to plans such as 401(k)s and Traditional IRAs are typically made with pre-tax dollars, reducing your taxable income in the year you contribute. This means you can defer taxes until you begin withdrawals in retirement, when you may be in a lower tax bracket. Additionally, the growth of investments within these accounts is tax-deferred, allowing your savings to compound without immediate taxation.

Employer Contributions

Many employers offer matching contributions to 401(k) plans, which can significantly enhance your total retirement savings. For instance, an employer might match a portion of your contributions, effectively giving you “free money” toward your retirement. This incentive can amplify your investment and is one of the reasons you should take full advantage of qualified plans in your workplace.

Portability

Many qualified plans offer portability features, meaning that if you change jobs or retire, you can roll over your retirement savings into another qualified plan or an IRA without incurring penalties. This flexibility allows you to maintain the tax advantages associated with your retirement funds while making it easier to manage your accounts as your career evolves.

Disadvantages of Qualified Retirement Plans

While qualified retirement plans offer numerous benefits, such as tax advantages and employer contributions, they also come with several disadvantages that participants should be aware of. Understanding these drawbacks can help individuals make informed decisions regarding their overall retirement strategy.

• One of the most significant drawbacks of qualified retirement plans is the contribution limits imposed by the Internal Revenue Service (IRS). For example, the 401(k) contribution limit for 2025 is $23,500 for employee salary deferrals and $70,000 for the combined employee and employer contributions. These limits may restrict higher earners from saving as much as they would like for retirement.
• Another significant issue with qualified plans is that the future tax rate when you take income out of your plan is unknown. Taxes will be due on the principal and growth of your money when you take distributions from the plan. Most people expect tax rates to be higher in the future due to the out of control government spending and federal deficit.  Therefore you might get a small tax deduction as you contribute to your plan, but then you are postponing taxes to later when the rates could be much higher.
• The distributions from your plan will also (negatively) affect the taxes on your social security benefits and the cost of medicare.
• Qualified retirement plans are subject to strict rules regarding withdrawals. If participants take distributions before reaching the age of 59½, they typically face a 10% early withdrawal penalty in addition to income taxes on the amount withdrawn. 
• Qualified retirement plans must comply with various complex regulations established by the IRS and ERISA. Employers are responsible for maintaining compliance with these guidelines, which can involve considerable time, effort, and expense.
• Many qualified retirement plans, such as 401(k)s, offer a limited selection of investment options, which could prevent participants from fully diversifying their portfolios. 
• Qualified plans often incorporate vesting schedules for employer contributions. This means that employees may not fully own the employer’s contributions until they meet specific tenure requirements.
• Some qualified retirement plans may charge management fees, administrative costs, and other expenses that can erode investment returns over time. 

What Are Non-Qualified Retirement Plans?

Nonqualified plans are retirement plans that do not meet the Internal Revenue Service (IRS) requirements to be considered “qualified.”

Unlike qualified plans, nonqualified retirement plans are not subject to the same rules and regulations, allowing for greater design and implementation flexibility. Nonqualified retirement plans offer employers an alternative way to provide additional retirement benefits to select employees. They are often referred to as executive or supplemental retirement plans.

Examples of Non-Qualified Plans

Non-qualified plans come in various forms, each designed to meet specific needs and preferences of employers and employees. Here are some common examples of non-qualified retirement plans:

• Deferred Compensation Plans
• Supplemental Executive Retirement Plans (SERPs)
• Split-Dollar Life Insurance Plans

Popular Wealth Building Strategies

Beyond qualified retirement plans, there exists a wide array of innovative approaches to wealth building, with new ideas emerging all the time. Wealth accumulation generally requires patience, as successful investors explore numerous avenues, including: 

• Stock trading
• Real estate investments
• Peer-to-peer lending
• Annuities
• Certificates of deposit
• Bonds
• Currency exchange
• Cryptocurrency
• Side businesses
• Passive income strategies, such as Airbnb rentals or book royalties. 

These strategies vary in terms of potential returns and associated risks. Many qualified plans accommodate various investment techniques, allowing you the freedom to either manage them yourself or rely on a skilled financial planner to streamline the process.

A growing wealth-building strategy that is gaining popularity involves leveraging life insurance, particularly indexed universal life (IUL) policies. This approach can provide tax-free distributions while minimizing exposure to stock market volatility, making it an attractive option for those seeking secure growth.

What is Indexed Universal Life Insurance?

Indexed universal life insurance focuses on building cash value as fast as possible. Its life insurance component provides significant tax benefits, making it a valuable source of retirement income. The cash value in an IUL is tied to a stock market index, typically the S&P 500.

However, because your money isn’t directly invested in the index, the insurer structures the policy with a growth floor, protecting you from losses. Additionally, there is a growth ceiling, generally ranging from 12 to 14%, though many options also offer uncapped growth potential. 

A knowledgeable agent can establish the IUL with higher premium payments for a lower death benefit. Even though this might sound a bit strange, it actually helps you build cash value faster. The less you spend on the death benefit, the faster you build the cash value.

How IUL Accumulates Cash Value

Indexed Universal Life (IUL) insurance is a unique financial tool that not only provides a death benefit but also allows for the accumulation of cash value over time. Here’s a closer look at how an IUL grows its cash value, making it an appealing choice for those looking to enhance their retirement savings strategy.

Flexible-Premium Payments

One of the standout features of an IUL is its flexibility in premium payments. Policyholders can adjust the amount and frequency of their premium contributions within certain limits. This flexibility means that if you are in a position to contribute more during profitable years, you can do so, potentially accelerating the growth of your cash value.

Interest Credits Tied to a Market Index

IUL policies credit interest to the cash value based on the performance of a specified market index, such as the S&P 500. 

Rather than offering a fixed interest rate, the IUL allows policyholders to benefit from the potential growth of the stock market while also providing a safety net through a guaranteed minimum interest rate. This means that during periods of market growth, the cash value can significantly increase, while during downturns, the policyholder is protected from losses, ensuring that the cash value does not decrease due to negative index performance.

Cap on Returns

While IULs offer the potential for substantial growth, they do come with caps on the maximum returns credited to the cash value. 

For example, if the policy has a 10% cap and the market index performs at 15%, the policyholder would still receive a maximum of 10% interest credited to their cash value. This cap is a trade-off for the policy’s downside protection, allowing for growth while safeguarding against market volatility.

Cost of Insurance and Policy Charges

It’s important to note that the cash value growth of an IUL is subject to costs associated with the insurance component and administrative fees. These costs can impact the amount of cash value accumulated. However, as the cash value grows over time, it may outpace these charges, especially if the policyholder consistently pays premiums and the market performs well.

Tax Advantages

The cash value growth within an IUL is tax-deferred, meaning that policyholders won’t owe taxes on the gains as long as the funds remain in the policy. This tax-deferred growth can benefit long-term savings goals, as it allows more of the accumulated cash value to compound over time.

Additionally, when the policyholder accesses the cash value through loans or withdrawals, it can often be done tax-free, further enhancing the financial advantages of an IUL.

Accessing Cash Value

Policyholders can access the accumulated cash value through tax-free loans or withdrawals, providing a source of funds for various needs, such as supplementing retirement income, funding education, or covering emergencies. This liquidity is a key feature distinguishing IULs from other life insurance products.

Flexible Access to Funds

One significant benefit of the Indexed Universal Life Insurance (IUL) compared to traditional retirement plans like a 401(k) or an IRA is that you can access funds from your IUL policy before reaching the age of 59.5 years without incurring any penalties.

How People Use IUL as Retirement Income

After a decade or so of accumulating cash value, you may find yourself with a substantial nest egg. Unlike qualified plans, there are no requirements for borrowing against your cash value. You can use it as you wish, without the obligation to take distributions. 

What most people do is take a set amount from it each year. This amount is calculated with the assistance of their agent or financial planner. It’s set to ensure that the amount you draw out, plus accumulated interest over your retirement, doesn’t exceed the total cash value. 

That way, you can’t outlive your money no matter how long you live. Plus, there will still be a life insurance benefit for your heirs. 

Remember that since the cash value continues to grow based on the total amount (rather than the total minus any loans), many people reach a stage where the growth of their cash value exceeds both their loans and accumulated interest.

Disadvantages of Indexed Universal Life Insurance (IUL)

While Indexed Universal Life Insurance (IUL) offers several appealing features, it is essential to consider its potential disadvantages to make an informed decision about financial planning. Below are key drawbacks associated with IUL policies:

Complexity and Understanding

IUL policies can be complex and challenging to understand. The way interest is credited based on market indexes, combined with the various fees and charges, requires prospective buyers to invest time and effort in comprehending the product thoroughly. Therefore, it is suggested that you work with an experienced insurance agent. At Abrams Insurance Solutions, we have been saving into an IUL for over 15 years to compliment our other savings vehicles. We are fiduciaries and will make sure that your policy is set up properly to maximize your benefits.

High Fees and Cost Structure

Compared to other investment vehicles, IULs often have higher fees (for the initial years of the policy).  However, these fees decrease over time and will often end up costing less than qualified plans while providing more benefits to the policy owner. These fees include insurance coverage costs, administrative expenses, and potential surrender charges if the funds are cashed out early.

Cap on Growth Potential

The cap on the returns credited to the cash value can limit the growth potential, particularly in a booming market. For instance, if the market index soars past the cap, policyholders miss out on additional gains, which could be seen as a disadvantage compared to other investment options that don’t impose such limitations. However, these caps provide a guarantee that you won’t lose money when the market declines.

Not a Replacement for Retirement Accounts

Individuals often consider IULs a retirement savings vehicle, but they should not be considered a substitute for qualified retirement plans like 401(k)s or IRAs. IUL’s are a great supplement to qualified plans since they protect your money from loss, allow for access to capital without penalties and provide tax-free distributions. IUL’s also provide a death benefit if the unthinkable happens and access to funds if you experience a long term care issue.

Not for Everyone

Not everyone can fully benefit from an Indexed Universal Life Insurance (IUL) policy. It is generally most suitable for individuals with an annual income of $60,000 or more and those under age 65.  Clients over age 65 may still want an IUL for death benefit protection rather than a tax-free income focus.

Comparing Different Savings Options

The chart below highlights features you may wish to include or exclude in the first column. The second column indicates the ideal wealth-building vehicle, which, unfortunately, doesn’t exist. Therefore, the next best approach is to maximize the number of checked boxes. 

Across the top row, various wealth-building options are displayed, starting with the IRA-401(k). Notably, this strategy only meets two of your desired criteria. Other options have one, two, or three checked boxes.

Conversely, Indexed Universal Life Insurance, listed in the last column, has the highest number of checked boxes, indicating that it most closely aligns with your preferred financial plan characteristics.

How to Increase Your Retirement Income 60% to 100%

For high-income individuals, an alternative worth considering is leveraging an Indexed Universal Life Insurance (IUL) policy.  In this case, a bank pays for 75% of your premiums, letting you start with a much higher cash value. This elevated starting point accelerates growth, resulting in an impressive 60% to 100% increase in your potential retirement income. 

Explore the benefits of leveraging your IUL further in this article. Please know that a minimum income of $100,000 is required to qualify for this program.

Ultimately, What’s the Best Option?

Choosing the optimal retirement strategy requires careful consideration of your specific circumstances, such as your income level, family obligations, and retirement aspirations.

For many individuals, leveraging traditional qualified retirement plans (QRPs) proves advantageous, particularly when an employer offers matching contributions. This established route provides a dependable foundation for retirement savings. 

However, enhancing your retirement strategy with an Indexed Universal Life Insurance (IUL) policy can be beneficial. It provides an additional income source that is protected during economic downturns.

For instance, traditional retirement accounts often faced substantial losses during significant financial crises like those in 2008 and 2020. An IUL acts as a buffer against such market volatility. That said, it should not be solely relied upon for retirement; failing to pay premiums could result in policy lapse, leaving you empty-handed.

Combining QRPs with an IUL offers the best of both worlds, spreading risk across multiple income streams.

Example

Since it’s difficult to understand the impact of a retirement plan without looking at numbers, here’s a sample of what different retirement accounts would look like for a 45-year-old man as he contributes and after he retires. We compare his investments in an IUL (in green) against a taxable account (in red), a tax-deferred account (in blue), and a tax-free account (in purple).

You can see the cash value potential of each type of retirement vehicle based on their tax status. Here is what happens with the cash after our test case retires and starts taking distributions. 

You will notice that the Cash Flow for the tax-deferred account is higher. That’s the amount our person would have to draw from the account to pay the taxes and retain $77,561 as income.

These charts show how running out of money in retirement may unfold. When we analyze longevity in retirement with consistent income withdrawals, the taxable account depletes by age 76, while the tax-deferred and tax-free accounts last until age 80. In contrast, the IUL continues to provide financial support through age 95 and beyond. Plus, the IUL also offers a sizable death benefit for your loved ones.

The best strategy involves maximizing your participation in qualified retirement plans, especially to fully capitalize on any employer-matching contributions. After securing these advantages, it’s wise to consult with a financial advisor to explore additional tax-free options, such as Indexed Universal Life Insurance (IUL), to develop a well-rounded and effective retirement strategy.

FAQs

1. What is an IRA?

An Individual Retirement Account (IRA) is a popular type of qualified retirement plan designed for individual investors to save for retirement with unique tax advantages. There are multiple forms of IRAs, such as the Traditional IRA, Roth IRA, and Simplified Employee Pension (SEP) IRA, each offering unique regulations and advantages.

2. What is a 401(k) Plan?

A 401(k) plan is among the most well-known forms of employer-sponsored retirement plans. Named after the section of the Internal Revenue Code that governs them, 401(k) plans allow employees to save a portion of their pre-tax income for retirement. These contributions are deducted directly from an employee’s paycheck, reducing their taxable income for the year, which can lead to substantial tax savings.

There are two primary types of 401(k) plans: traditional and Roth. In a traditional 401(k), employee contributions are deducted from their paycheck before taxes, allowing immediate tax relief. However, withdrawals taken during retirement are subject to income tax. Conversely, contributions to a Roth 401(k) are made using after-tax income; while there is no tax deduction at the time of contribution, eligible withdrawals—termed “qualified distributions”—are free from taxes, providing tax benefits in retirement.

3. What is a 403(b) Plan?

A 403(b) plan, similar to a 401(k), is a type of employer-sponsored plan specifically designed for employees of public schools, certain tax-exempt organizations, and some ministers. 

These employer-sponsored plans, named after the section of the Internal Revenue Code that governs them, allow employees to save for retirement on a tax-deferred basis, providing them the opportunity to accumulate savings without immediate tax liabilities.

4. What types of retirement plans are available for small business owners?

Different types of retirement plans are available for small business owners including: 

• SIMPLE IRA Plans: Designed for businesses with 100 or fewer employees, SIMPLE IRAs allow both employer and employee contributions. Employers must either match up to 3% of salaries or make a 2% contribution for all eligible employees, offering a straightforward savings solution.
• SEP Retirement Plans: SEPs enable small business owners to make tax-deductible contributions for themselves and their employees. Funded by employers, SEPs have high contribution limits, appealing to those seeking flexibility.
• 401(k) Plans: Many small businesses offer traditional 401(k) plans, allowing employees to save pre-tax, with optional employer matching.
• Profit-Sharing Plans: A profit-sharing plan lets employers contribute a portion of profits to employee accounts, offering flexibility based on business revenue.

5. What is the difference between qualified plans and nonqualified plans?

Qualified Plans: These plans must adhere to specific rules set by the IRS, including compliance with the Employee Retirement Income Security Act (ERISA). As a result, they offer certain protections to employees, such as mandatory participation for eligible employees and specific funding rules. Examples include 401(k) plans, IRAs, and 403(b) plans.

Non-Qualified Plans: Unlike their qualified counterparts, non-qualified plans do not need to comply with ERISA regulations and do not enjoy the same level of tax benefits. These plans are typically used by higher-earning employees and include arrangements like deferred compensation plans or executive bonus plans. They offer greater flexibility regarding contributions and benefits, but they also come with increased risks, such as reliance on the employer’s ability to meet its financial obligations.

How Abrams Insurance Solutions Can Help

By collaborating with Abrams Insurance Solutions, you gain access to a wealth of knowledge and expertise that can help you navigate the complexities of retirement planning.

Whether you’re just starting out or are nearing retirement, our team is committed to supporting you every step of the way, ensuring that you achieve your financial goals with peace of mind. Don’t leave your future to chance; let us help you build a comprehensive, well-rounded retirement strategy today!

Give us a call today at 858-703-6178 or use the form on this page to request a customized Wealth Report. The Wealth Report will compare the after tax distributions when saving the same amount of money into a taxable, tax-deferred, tax- advantages account and an IUL.