How Indexed Universal Life Can Support a High Earner’s Retirement Strategy

Indexed universal life insurance can combine lifelong protection with a source of supplemental retirement income, if the policyholder has the right goals, resources, time frame and policy design.

A person with a high income may save steadily for decades and still encounter a tax challenge in retirement: Much of their nest egg may sit in accounts where withdrawals are taxed as ordinary income, leaving little room to control that burden.

Eligibility for direct Roth contributions may already have ended.

Indexed universal life insurance, or IUL, can help address part of that problem. It offers a death benefit, and its cash value may later serve as an additional source of income.

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For savers who have already maxed out traditional tax-advantaged accounts and want greater control over retirement income, IUL may be worth a closer look.

Cash value grows tax-deferred inside the policy, and the owner may later tap it through withdrawals or policy loans that are generally not subject to current income tax. That only works if the contract is structured correctly and remains in force.

This mix of tax-deferred accumulation and potentially tax-favored access is what sets IUL apart from other retirement savings tools.

LIMRA, the Life Insurance Marketing and Research Association, said IUL premiums hit record levels, rising 17% from the previous year. Strong sales do not by themselves prove a product is right for any one client, but they do signal growing interest in how permanent life insurance can fit into a modern financial plan.

About Adviser Intel

The author of this article is a participant in Kiplinger's Adviser Intel program, a curated network of trusted financial professionals who share expert insights on wealth building and preservation. Contributors, including fiduciary financial planners, wealth managers, CEOs and attorneys, provide actionable advice about retirement planning, estate planning, tax strategies and more. Experts are invited to contribute and do not pay to be included, so you can trust their advice is honest and valuable.

High earners can eventually exhaust familiar tax-advantaged space

The pressure becomes clearer during the years of peak earnings. Employees can contribute up to $24,500 to a 401(k), excluding catch-up contributions. Direct Roth IRA eligibility phases out from $153,000 to $168,000 for single filers and from $242,000 to $252,000 for married couples filing jointly.

Those limits are not a reason to buy life insurance on their own. First consider workplace plans, health savings accounts, backdoor Roth strategies, taxable investments and adequate liquid reserves. Still, a high earner with extra cash flow and a real need for permanent coverage may have room for another layer.

Cash value can create another retirement-income layer

An IUL policy builds cash value and credits interest partly based on the performance of an outside index. The money is not directly invested in that index. Caps, participation rates, spreads, guarantees and policy charges all affect the amount of interest credited.

Growth inside the policy is tax-deferred. Later, the owner can access cash through withdrawals and loans, potentially without current income tax if the contract is properly structured, avoids modified endowment contract status and stays active. That access can supplement qualified-plan distributions, Roth withdrawals, taxable investments and guaranteed income from annuities.

This additional income source may be useful in a high-tax year, after a market downturn or before drawing from another retirement asset. Tax flexibility is one of the main arguments for IUL. The policy does not have to replace a retirement account to add meaningful value.

The right buyer needs more than income

The strongest IUL candidates usually share several traits:

• They are often between ages 40 and 55 and have time to fund the policy before relying on the income.
• They have steady surplus cash flow after covering other retirement priorities and liquidity needs.
• They need permanent life insurance for family, estate or business reasons.
• They understand that surrendering early can be costly, and that a long-term horizon is part of the plan.

Someone with unstable income, limited reserves, a short time frame or no insurance need will likely need a different approach. IUL tends to work best when both parts of the contract matter: protection for beneficiaries and carefully managed access to income for the policyowner.

Tax advantages do not eliminate policy risk

Loans accumulate interest and reduce both cash value and the death benefit. A policy that has been heavily borrowed against can lapse, which may trigger taxable income at an unfavorable time. Policy charges still apply, interest-crediting terms can shift and illustrated outcomes are not guaranteed.

Prospective policyowners should examine lower crediting assumptions, changing policy terms, missed premiums and growing loan balances before making a commitment.

The NAIC's life insurance illustration guidance helps structure that review. AI-enabled planning tools can quickly compare funding and loan scenarios. Even so, they cannot determine whether the death benefit is needed or whether the owner can maintain the policy for decades. Ongoing human review and updated in-force illustrations still matter.

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Decide what the next dollar should do

For financial advisers, the next review with a high-income client should start by mapping the tax treatment of existing retirement assets. Then ask where the next long-term dollar should go and what role it needs to play.

If traditional savings options are already covered, permanent protection is needed and another possible source of tax-advantaged money could strengthen the income plan, compare an IUL with the available alternatives. Use conservative projections, explain the conditions clearly and build annual reviews into the recommendation.

Life insurance is intended to protect people after death. For the right high-income earner, a properly designed IUL policy may also help during the decades before that.

Strategies described herein are made possible by the use of policy loans against the cash value of the policy. Policy loans reduce the death benefit of a contract in the amount that is outstanding and may include interest as well. Employing a strategy utilizing policy loans has the potential to be classified as a MEC (Modified Endowment Contract) which poses additional consequences. The strategies or products discussed may not be suitable for all individuals. All investing involves risk, including potential loss of principal. Individual results may vary based on unique circumstances. Consult a qualified financial professional to discuss your specific situation and suitability needs. For specific tax planning advice or services, please consult a qualified tax advisor or CPA.

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.