Is a 401k or Investing better than Whole Life or IUL?
A lot of people ask me this question. It is difficult to really get a good answer out of anyone because if the advice comes from a person that likes the stock market they say “Hands Down go with investing!” Conversely, if someone is into Life Insurance they say just as loudly “Insurance is way better!”
So, how do you get a straight answer? Well, I have my own way of looking at things and if you’ll permit me to share what I think about it may help you in making the best decision for you. Not the best theoretical decision or the one that is based on modern financial computations, or projected algorithms but one that works for your life. You see I am a firm believer that YOU are the best judge of what is a good idea for you. I cannot tell you how to invest, or the “best” idea, because theories cannot tell you what you are going to be comfortable with, or how things will work out in the future. You see, YOU and only YOU have to live with the choices you make. A financial advisor doesn’t have to live your life. They get to give advice and then go live their own life.
Make sure the choices you make fit you and not the latest and greatest theory.
When someone asks me about the difference between using a traditional retirement vehicle (401k, IRA 403b etc.) an investment account and Life Insurance, I start talking about two things.
First I talk about taxes. You see I don’t just look at potential growth or rate of return. I care about how much money you get to put into your pocket after everything is said and done. It doesn’t matter if you made 100 million, if you don’t get to put it in your pocket and spend it. If you end up paying 100 million in taxes then you have nothing. At that point the interest rate on your money is a pretty pointless thing. Now, paying 100% in taxes is a silly example but you get my point.
Most advice focuses on how much growth is possible, not how much you will get to keep!
We have all been taught that paying taxes later is the best way to have a large amount of growth. I’m not convinced that this is actually true. Because in the end you just have to pay the same percentage in taxes. That brings up a good point that I also mention. What is the tax rate going to be when you need your money? Now that’s a question no one can answer. Traditionally we have all been told that when we retire our tax bracket will be lower so it will work out to less taxes. Well, what if the lowest tax bracket we fit into is 65%!!!! Back in the 50’s and 60’s the upper tax bracket was 90%. I know that all starts to sound a bit negative, but it is a reality that we need to look into for your future. Ask yourself this question:
“Do I think that taxes are going to be lower or higher when I need to use my money?”
The second thing I like do is ask a question: How much do you like risk? I have found that the potential of lots of gains tends to make us all very happy to think about. The reality of risking money however is not something most of us are comfortable with. Lets paint a scenario.
Your friend Bob walks up and says he needs $5,000. You ask what for? He says he has a good business idea and if you give it enough time you’ll get back $10,000. That sounds pretty good. So you give him the $5k. A week later you ask him if you can get your money back. He says he can give it back but right now he only can give you $5100. If you wait some more you can probably get closer to $10k. You decide to wait. A month later you ask Bob for the money. He says things didn’t go well so now he can only pay you back $8700. But if you wait it could be a lot more. You decide to wait….
This could go on and on but I think you get the idea. If you wait you could get up to $10,000. That sounds like a great thing. But if you hit Bob up on a bad day he might not even be able to give you back your $5k. That kind of hurts the bank account.
Risk is only a good thing if you don’t need the money.
So ask yourself this question:
When you need the money are you comfortable not having it all there exactly when you want it? Can you be ok with waiting?
Going back to the original question: Which is better, an investment based account or Insurance?
I’m going to answer that question with “That depends on how you answered the questions above.”
If you like the idea of making great returns and you can handle the idea of potentially loosing a lot of it or not having it availible when you need it. If you are not concerned with taxes leaving you with less even if you make more, then Investment based plans are a great fit for you.
However if you don’t like risk or at least not a lot of risk, and/or you are really concerned with future taxes, then using Life Insurance for future planning could be a great fit for you. This is all fine and dandy but lets get to some real world scenarios and you can decide for yourself which one looks better for you.
I like numbers personally. I know everyone likes to show fantastic numbers but life doesn’t work out like it is supposed to on paper most of the time. So when I run numbers I like to run averages and then add a “grain of salt” (meaning I add my own skepticism and run it against everything I know).
I wanted to find out what it looked like to run an investment account (in this case a generic 401k) against the tax free Whole Life and Indexed Universal Life products I work with.
If your unfamiliar with WL or IUL let me give you the short version. They are both permanent (they last until you die even if that’s at age 120). They both have a cash portion that you can access through loans when your alive. You can use them for anything, at any time without penalty (you will have to pay interest). WL pays you in a dividend (a rate the company picks at the beginning of each year based on how much they made last year). IUL looks at how a stock Index performs and gives you a portion of that as interest. IUL is not invested in the market and you are guaranteed to not loose money (some even guarantee a small percentage). IUL has a chance of making 10% each year (that’s what one product is currently doing the rates can vary).
So bellow there is a chart that shows a 25 year old contributing the max of $19,000 a year into all of the products until age 65. I linked the xcell document if you want to look at all the details. I am able to run the WL and IUL products myself to see how they would do. For the 401k I went with an average. I got the averages from Investopedia. I ran several scenarios of different rates of return 3%, 5%, and 7%. I then applied two current rates of taxes, 24% and 31% (I hoped you were going to make a bit of money with all of this). I then took them all and averaged the returns and the tax rate.
The results re the chart bellow.
You can see that the average return for the 401k was higher than either the IUL or the WL by quite a lot. However once you take away the taxes it really didn’t do much better than the WL and it did worse than the IUL. Now, the thing to remember is that the WL is not only likely to do this well, but historically the companies I’m working with have payed even more in the past. They have not missed a dividend payment even in the great depression and WW1 or WW2. You can reasonably expect they will continue to make money and pay dividends in the future.
The IUL is still based on the stock market performance. Even though you can’t loose money, you still don’t know how much or how often you’ll see good returns.
So, what is better for you? Making a lot but paying a lot of taxes? Making some at almost no risk? Making a good bit but having some risk as to how much?
Should you consider going all in on the tax free side? Should you split things up and do investments with some and a get a WL and an IUL? Do you like no risk at all and the WL sounds good?
Only you can answer these questions. I am here to help you take a good look at your specific scenario and determine what your options are. Unfortunately, I can’t tell you which is the best choice for your life. I do promise though that I will answer all questions you have and do my best to discover all the possibilities that Insurance products can offer.
Contact me if you would like a one on one conversation about all this.