Saving for retirement is essential, but according to a recent survey, almost two-thirds of Americans fear their retirement planning is not on track. Smart long-term planning is critical if you are not going to struggle to make ends meet once you stop working.
Roth IRAs and IULs are retirement savings plans that can both provide significant income in retirement by allowing pre-taxed contributions to grow over time. However, they have very different aims, risks, and cost structures.
Let’s take a closer look at how each of these products works and their major similarities and differences. We’ll also consider the potential advantages and disadvantages of each for different kinds of investors so you can decide which one might be better to help build your retirement nest egg.
WHAT IS A ROTH IRA?
A Roth IRA is an individual retirement account that allows you to invest money you have already been taxed on for use once you stop working. Funds invested in a Roth IRA grow tax-free and can be withdrawn tax-free once you reach age 59½.
Contributions to a Roth IRA are currently capped at $6,500 a year, or $7,500 if you are over the age of 50, provided you earn a modified adjusted income of less than $153,000 if filing individually or $228,000 if filing jointly.
Roth IRAs are usually individually held, unlike the 401(k) retirement plans commonly offered by employers. They can be invested in many different ways, but are generally designed to deliver low-risk returns over a sustained period of time.
While tax-free emergency withdrawals are possible, you will pay a heavy penalty if you tap your Roth account in the first five years of holding it. After that, early withdrawals may be charged a 10% penalty and the interest you have earned will be taxed, although money spent on certain qualified education expenses is often exempt.
While setting up a Roth IRA is usually free, you’ll pay a monthly or annual account maintenance fee plus any transaction fees or commissions levied by stockbrokers managing your investment.
PROS OF ROTH IRAS
Roth IRAs are a widely available and relatively straightforward retirement savings option. Some of the major advantages of Roth IRAs include:
- Safe, steady savings: Most Roth funds are invested to deliver reliable long-term growth.
- Tax-free growth: You don’t pay capital gains tax on your earnings.
- Tax-free distribution: Money is disbursed tax-free once you reach the age of 59½.
- Relatively low fees: These include maintenance fees plus investment commissions.
- Smart withdrawals: It’s possible to withdraw some money tax- and commission-free to help fund a home purchase or to pay for certain education expenses.
CONS OF ROTH IRAS
At the same time, Roth IRAs are a long-term commitment and it is important to be aware of some potential drawbacks, including:
- Capped contributions: You can only contribute if your income is below a certain amount.
- Possible losses: Your investment could potentially lose value in the short term.
- Withdrawal rules: You will usually pay a penalty if you withdraw money early.
- Possible taxes: You might pay taxes on the interest you have earned if you withdraw money early.
- Inheritance costs: Your beneficiaries might have to pay taxes on inherited funds.
WHAT IS AN IUL?
An Indexed Universal Life (IUL) policy is a type of life insurance policy that allows you to invest extra funds above those spent on your insurance premium in a pre-taxed retirement fund. These funds are usually invested in a fund that tracks a major diversified index, such as the S&P 500, with caps on earnings and a floor on losses to protect your principal and ensure steady growth.
You can contribute as much as you like to an IUL over and above your premium and money can be withdrawn tax-free and without penalty at any time. Also, because the money is not invested directly in the stock exchange, investors do not have to pay capital gains tax on interest, making it a good way to offer a tax-free death benefit to your beneficiaries.
As an insurance product, IULs usually include a hefty commission for the representative who sells you the policy, paid off over time. You will also pay administration fees and other charges associated with your insurance policy.
PROS OF IULS
IULs offer the “two-for-one” benefit of getting both permanent life insurance coverage and a tax-free retirement investment in a single product. Other advantages include:
- No limits or income restrictions on contributions
- Potentially higher investment earnings than other retirement products
- No penalties or age limits on withdrawals
- Floor on investment losses to limit risk
- A locked-in permanent insurance premium
- Tax-free payout to beneficiaries
CONS OF IULS
While there are many benefits, IULs are hybrid products that come with some significant drawbacks compared with Roth IRAs and other more traditional retirement products. These include:
- High commissions, fees, and insurance premiums
- Complex regulations and terms
- Higher premiums if you are older or have existing health issues
- Earnings are capped to limit volatility
- Indexed earnings can be limited by a crediting formula
HOW DO ROTH IRAS AND IULS DIFFER?
The following table summarizes the key differences between Roth IRAs and IULs.
|Contributions||Contributions are capped annually and prohibited if you earn above a certain level||Contributions are unlimited at any income level|
|Withdrawals||Withdrawals are subject to a penalty and interest is taxed before age 59½||Withdrawals are tax-free with no penalties and can be made at any time|
|Fees||Maintenance fee plus any investment fees and commissions||Commission, ongoing premium payments, plus investment commissions and fees|
|Risks||No limit on investment earnings or losses||Cap on earnings, floor on losses|
|Beneficiaries||Beneficiaries may have to pay taxes||Beneficiaries receive a tax-free insurance payout|
ROTH IRA VS. IUL: WHICH ONE IS RIGHT FOR YOU?
Although they have some basic similarities, Roth IRAs and IULs offer very different approaches to savings for retirement. Which one is better for you depends on your current financial situation as well as your retirement plans. Let’s take a look at when choosing one product over the other makes the most sense.
WHEN TO USE A ROTH IRA
Roth IRAs are designed to maximize your retirement savings by taxing contributions up front and providing significant flexibility in how you invest those savings. To do this, however, there are limits on how much you can contribute and restrictions on when and under what circumstances you can withdraw money.
Opening a Roth IRA makes the most sense if:
- You have a relatively low income, but you expect to earn more in the future
- You prefer a simpler product with low and fairly predictable costs
- You want a choice of investment options for your retirement funds
- You want the option to withdraw money to help buy a home or pay for your child’s education
This makes a Roth IRA a good product to invest in relatively early in life, when you have time to ride out market fluctuations and when your tax liability is lower. It makes particularly good sense if you are self-employed or an independent contractor who wants to plan for retirement.
WHEN TO USE AN IUL
An IUL combines the benefits of both long-term life insurance and a retirement savings account. While it may seem convenient to get two services with one product, it is also a relatively cumbersome process and ties your retirement nest egg to your personal health outcomes.
The main reason for choosing an IUL is to ensure your remaining retirement savings can be disbursed to your beneficiaries at your death as a tax-free life insurance payout that is not subject to capital gains and inheritance taxes. You’ll also likely enjoy years of tax-free, low-risk investment growth while being able to tap your funds whenever you like.
Opening an IUL makes the most sense if:
- You already have a 401(K) or individual IRA but want to diversify your investments
- You are relatively healthy
- You are able to invest enough to offset high commission charges and fees
- You want to protect your money from unexpected market fluctuations
- You expect to pass significant savings on to your beneficiaries
- You want the option to dip into your retirement funds at any time without penalties
In short, while IULs offer a lot of flexibility and easy access to your money, they are also complex products that can take a lot of time and effort to administer. They really make the most sense to high net-worth individuals who already have other retirement savings and are looking for a good way to grow wealth and pass it on to their descendents.
For the rest of us, Roth IRAs offer a simpler, more direct way to save for the future. They include common sense restrictions that reward careful, consistent savings while offering ways to tap your savings for sensible expenses like your child’s education.
WASATCH PEAKS CREDIT UNION: YOUR ROTH IRA PARTNER
If you’re looking to build a career in northern Utah’s vibrant and diverse business community, a Roth IRA can be a smart place to start setting aside money or supplement your employee-matched 401(k).
A Roth IRA from Wasatch Peaks Credit Union allows you to pay taxes now and then enjoy tax-free withdrawals later. There’s no minimum deposit required to open or maintain an account, and you’ll earn interest on any deposited funds. You can also contribute up to $6,500, or $7,500 if you are over age 50, every tax year.
In addition, with a Wasatch Peaks Roth IRA, you can:
- Withdraw your contributed funds tax- and penalty-free at any time
- Withdraw money for a first home purchase or qualified educational need
- Withdraw earnings as and when you need them after age 59½ (if you’ve had the account for 5 years)
- No required minimum distributions (RMDs)
Best of all, unlike direct market investments, your deposits in a Wasatch Peaks Roth IRA are insured by the NCUA up to $250,000. Your money will continue to grow tax-free and risk-free until you are ready to use it.