IUL Insurance: Recession-Proof or a Risky Bet for Your Retirement?

16:31And so those fees can shoot up. And in a bad stock market year, you might be earning 0%, but you're still paying a lot of fees. So the cash value, the interest you're earning, no, that's not going negative. But your policy as a whole can still lose money because the fees are draining money from an account that's not earning anything from the stock market.

16:53Sean Pyles:And that's a particular nuance that people won't be explaining in a 30-second TikTok or Instagram video. And that's where things get really frustrating because having seen personal finance content for so many years online, it seems like almost every nine to 12 months, there's some new magic way to make money. Like infinite banking was one that we would hear about, or people would go and deposit a check into their ATM and just put a bunch of money in and basically try to defraud their banks. That was one that was happening a year or two ago. So anytime there's some big claim of a product that seems like it's a guaranteed way to make money really easily, I would be highly skeptical of that.

17:32Absolutely. I agree. That is wild that people were going around writing checks to themselves. And a lot of times, yeah, these guaranteed claims going around on social media, you really need to pay attention to who's making these claims and what they stand to earn from them, why they're trying to convince you so hard. With IULs in particular, there are a lot of risks that they don't mention. They don't mention the fees. They also don't mention that these fees are usually front loaded onto the first 10 or 15 years of your policy. So you're paying higher fees upfront. And that gets really risky if the stock market has a couple bad years in a row during those early years of your policy.

18:12Well, then you're earning 0%. Your fees are particularly high and you haven't had any time to build up cash value in your policy that the fees could potentially come out of. So now you're having to shoulder all the burden of those fees. Your policy is getting drained. And when the cash value in your policy isn't covering your fees and the cost of insurance, you're eventually going to get a notice in the mail saying that your policy is in danger and you need to make much higher premium payments if you want to keep it afloat. And the worst part is that insurance companies don't always give you a lot of notice.

18:50They're not going to warn you in advance that, hey, your policy is starting to get drained. You might want to put a little money into it. Unless you're really paying attention and really on top of it, you're checking your policy and you understand your policy, you might not know until the last minute when all of a sudden your premium tripled. And if you don't start paying that right now, your policy is going to collapse. And again, if your policy collapses, then you lose everything you put into it. So it's a very high risk.

19:21Elizabeth Ayoola:You took the words out my mouth. This sounds extremely high risk to me. I'm sure we're going to get into some pros, but all my ears are hearing right now are cons, especially because there are no caps on how much I can earn from my investments in the stock market. And yes, there are ups and downs in the stock market, but we all know the rate of return. So I'm not going to bore you with that. So tell us, Lizzie, are there any good things or I would say pros of having an IUL? There are certainly some pros. I would say the 0 % floor is a real benefit. I talk about how that doesn't mean you can't lose money.

19:53It still does offer a good amount of risk protection in terms of not having to suffer big stock market losses. And this is rare for a product that is indexed to the stock market or has the potential to sometimes earn stock market-like returns, you're usually not going to get that kind of downside protection. So that's definitely a pro. The returns that you're earning are also real. And even though there are a lot of limits placed on those, they do offer some level of participation in the stock market. And your earnings in the IUL grow tax deferred, so there are tax advantages involved. If you want permanent life insurance, if you're the type of person who has a need for that, then the fact that these policies are permanent and they are intended to last for your whole life and you can leave an inheritance to your family that's shielded from taxes is also another benefit.

20:46Sean Pyles:So Lizzie, obviously, this is a pretty complex topic. We'll be back in a minute with more about indexed universal life insurance.

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22:47Sean Pyles:Lizzie, a lot of folks on social media were claiming that indexed universal life insurance can be preferable to a 401k for retirement investing, something that I'm clearly obviously very skeptical of and for good reason. What are people saying about that online in more detail? And why do they think this might actually be better than a tried and true retirement account? Great question. It's definitely smart to be skeptical when someone is telling you that an insurance product is better for retirement than a dedicated retirement account. An IUL is not a retirement account. It's not an investment account.

23:23Again, it's a life insurance policy. and a lot of these videos online are claiming that an IUL is better for a 401k. It's the best way to provide yourself with a safe tax-free retirement and they usually use two arguments that have to do with both market risk and taxes. The argument around market risk just goes back to that zero percent floor that you can't lose money in an IUL even though you can but you don't have to suffer from market crashes with the IUL. We've already talked a little bit about why that claim isn't fully true, even though, yes, during a market crash, you're not going to go into the negative.

24:04You can still lose money. Plus, there's that cap on growth and that opportunity cost there where you could have taken that money and you could have invested it into a 401k or some other type of retirement account and done really well during good stock market years. Instead, you put it in this IUL and now you're not able to earn and grow that money as much as you would during those good stock market years. So there's an opportunity cost involved with these products that you don't see with a 401k. And then there's the tax component. And the way that these videos talk about the tax benefits of IULs is a little misleading.

24:47They call it tax-free retirement income because you can take tax-free loans from an IUL. Whereas if you have a 401k, the money that you withdraw in retirement, if it's a traditional 401k, is going to be taxed. But you're still taxed the same number of times regardless of whether it's a 401k or an IUL. With a traditional 401k, you get a tax break up front when you put your money into the account. And then you're taxed on the money when you take it out. And an IUL is just the reverse. You're taxed on your money before you put it into the account, but then you get a tax break on the money coming out of it.

25:23If you prefer to have tax-free withdrawals in retirement, there are other options that are specifically geared towards saving for retirement. You can use a Roth 401k or a Roth IRA, and you'll get that tax-free growth, but you won't be having to put some of that money toward insurance fees.

25:42Sean Pyles:expensive insurance fees that will be going up over time. Oftentimes when a financial product is trying to do two things at once, it doesn't really do either of them very well. And an IUL can be a really good example of that. The money that you're putting into it isn't just going toward retirement. It's paying for your life insurance. Whereas a 401k has one job. It is to accumulate money toward your retirement.

26:04Elizabeth Ayoola:Lizzie, don't you think it's important who is saying that 401ks are potentially better than IULs because oftentimes we're consuming content online and we're not checking people's credentials. We're not seeing if these are people qualified to speak on these subject matters and also if they have a stake in it. It's very important too when you're seeing these videos, click on the profile, see who is making them, go to the link in their bio, see what their credentials are and why they're selling these products, why they're pushing them so hard. Is it because they stand to make money off of you if you buy them?

26:38Usually, in most cases, I found that they are selling IULs because they want to make money off of you. And it's a problem in particular with IULs because they exist in this weird regulatory limbo. They're in kind of a gray area where they're not an investment product, but they're often being marketed and sold as an investment product. because they're not legally an investment product, they don't fall under the same regulations as a 401k or an investment account would. And so the people selling them aren't held to the same strict requirements. They don't have to have the same credentials as someone selling an investment product.

27:19And they also don't necessarily have to keep your best interest in mind when they're recommending products to you. So it allows these people to leave out a lot of information and essentially mislead consumers, whereas investment products are regulated more heavily and people selling them aren't able to do that as easily.

27:42Elizabeth Ayoola:Since it's not an investment product, it's not a retirement product, to just this point, where should it fit into your retirement planning if you are going to use an IUL. That's something that while I was writing my article, I talked to a lot of experts about. And the general consensus there was that IULs are a very niche product. They're very specialized. And most people do not need them as part of their retirement portfolio. There may be some people out there for whom an IUL makes sense. Those people should be people who understand the IULs and how they work. And they generally should have already maxed out their 401k and other tax advantaged retirement accounts.

28:28And if you've done all that and you still have money left over and you're looking for a place to put it, and you have a need for permanent life insurance, then an IUL might make sense for you as long as you understand what you're getting into. Another expert I talked to, a CFP and life insurance analyst mentioned that they are good moderate risk profile products. So if you're looking for a product with moderate risk because of the caps and floors, there's downside protection, but you're also not investing in something that's going to earn you any type of aggressive returns, then it's good if you're looking for something that's offering moderate growth and can limit your downside a little bit.

29:08Sean Pyles:Well, let's zoom out a little bit and think about how life insurance fits into people's general financial planning. And I always recommend people think about the goal behind any kind of financial product, but especially life insurance before they acquire it. Is their goal of life insurance to protect their family's financial security in the event of their death? Or are they trying to build wealth or a way where they can take loans out in retirement without any sort of interest? Like you said earlier, Lizzie, accomplishing both of those things at the same time is really challenging. And NerdWallet's house view tends to be that most people are actually really okay with just a term life insurance policy because they are so much less expensive and people's needs are going to be changing over time.

29:51Sean Pyles:They might not need a life insurance policy up until the day they die. Can you elaborate on this a little bit? As Sean said, our house view is that for most people, term life insurance is the right choice. It's temporary. You're not going to have lifelong coverage. But again, most people don't need that. So if you have 25 years left on your mortgage and a newborn, and you think that your mortgage is going to be paid off in 25 years, your child is going to be grown and financially independent, and you're planning to have some money in savings, some money in a retirement account that can help protect you, then in 25 years, you might not need that death benefit anymore.

30:30So getting a policy with a 25 or 30 year term is sufficient and generally so much cheaper than a permanent life insurance policy. A lot of times if you are a healthy adult in your 30s, even 40s, you can get a term life insurance policy for$20 or$30 a month, which is less than I spend on cold brew. So they're very affordable products. They're very low risk, especially compared to something like an IUL. And they're very straightforward and simple. You don't have to understand all the ins and outs of how a policy is being charged fees and earning money. It just does one thing and it does it well.

31:10Elizabeth Ayoola:From one Elizabeth to another, thank you, Elizabeth Aldridge, for coming on and explaining to us the complexities of IULs and reminding me that I don't need one. Thank you both so much for having me.

31:23Sean Pyles:That's all we've got for this episode. Remember folks to send us your money questions. We need them. We love them. We read and listen to all of them. So leave us a voicemail or text us on the nerd hotline at 901-730-6373. That's 901-730-NERD. You can also email us at podcast at nerdballet.com or drop a comment on Spotify or YouTube.

31:42Elizabeth Ayoola:The Smart Money Podcast wouldn't be what it is without you. So join us next time to hear about how one family is helping their father recovered from sending all of his retirement savings to someone he met on OnlyFans. Follow Smart Money on your favorite podcast app, including Spotify, Apple Podcasts, and iHeartRadio to automatically download new episodes. And hello, we're on YouTube. Go and follow us. Go watch our videos. The link is in the episode description.

32:08Sean Pyles:Here's our brief disclaimer. We are not your financial or investment or insurance advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances. Some companies mentioned in this episode may be NerdWallet partners, but does not influence how we talk about them.

32:23Elizabeth Ayoola:And with that said, until next time, turn to the nerds.

32:31Sean Pyles:Hey, Smart Money fan. If you're getting this, it means that you're living in the Chicago area where Elizabeth and I are going to be recording some live episodes really soon. And we want to hear from you.

32:40Elizabeth Ayoola:And if you have been following the show, you know that Chicago has become my second favorite city in the world. And I'm so excited to be there. We want you to do us a favor and start sending in your money questions, especially if you want to come sit with us live. Maybe you have an issue with retirement savings and you're falling behind. Maybe you are trying to figure out how on earth you're going to budget in the current economy. Whatever your question is, we want to hear from you.

33:04Sean Pyles:Email us at podcast at nerve wallet.com with the subject line, Chicago with your question. And hopefully we can talk to you when we're in Chicago in mid October. Fall has never looked or tasted this good. Sweetgreen's fall harvest menu is back with seasonal favorites dressed to impress and made to be devoured. Warm roasted sweet potatoes, crisp apples, maple glazed Brussels and crave worthy flavors in the autumn harvest bowl, maple glazed salmon plate and roasted bacon Brussels side. The season's most desirable menu has returned to Sweetgreen featuring fall's best dressed. Make your move. Order on the Sweetgreen app.