IUL vs. annuities: Settling the debate

This subject gets a lot of agents pretty jazzed.

There are two pretty entrenched camps on indexed universal life and annuities. And those two camps don’t seem to like each other very much. I wouldn’t classify the conflict on the level of the Hatfields and the McCoys, but it’s close.

Whether you’re just entering the life insurance industry or you’re an experienced life insurance agent looking for something new, there is good news for you both. Rather than focus on pros and cons of the products, we have identified the needs of three high-potential customer segments. This will give you stronger context to prioritize the products for policyholders. You can be their agent and trusted advisor by simply asking good questions ahead of making product recommendations.

What is better: IUL or annuity?

Neither. They are different insurance products designed to solve different problems.

The annuity vs. IUL discussion/argument has a long history. In the context of financial planning, it’s not unusual for conversations about the two products to focus on what they are not, versus what they are. We are going to take the high road and focus on the latter to define the key differences.

Let’s first do a level set on definitions.

• Indexed Universal Life: This is a type of permanent life insurance, like whole life, that offers a lump sum death benefit payout to beneficiaries and a cash value component with the opportunity for withdrawals and loans. The cash value can grow based on the performance of a stock market index, such as the S&P 500, without being directly invested in the market. This means clients get the upside of a positive market performance (with caps) with the protection against market downturns using a guaranteed minimum interest rate (typically 0% or 1%). Additionally, IUL policies offer flexibility in premium payments and death benefit amounts.

• Annuity: Annuity products are designed to provide a steady income stream, primarily used for retirement planning. There are three primary types of annuities: fixed, variable and indexed. Annuities can offer guaranteed income for life, which is particularly beneficial for clients worried about outliving their savings. Depending on the type, annuities can provide a stable return, growth potential with some market exposure, or a mix of both.

Insurance agents often get a bad name with financial advisors as both of these products are often marketed as investment by inexperienced insurance agents, which is not only out of compliance, but entirely false.

Read more about misconceptions of IUL to make sure you’re on the right track.

How do annuities compare to IUL?

Although both financial products may be tied to market indexes, their primary purposes differ. IULs are insurance products with a tax-free death benefit that also include cash value accumulation. Conversely, annuities are designed to convert savings or other types of lump sum accounts such as a 401(k), individual retirement account or Roth IRA, into a predictable income stream your clients will not outlive.

An easy way to think about this is how each product impacts your client’s earning power:

• IUL at its core is designed to protect from the risks of dying too soon.
• Annuities protect from running out of money.

Each product has moving parts that allow it to often accomplish more than its base level purpose.

The magic is knowing how and when to use each type of product.

Customer scenarios: IUL vs. annuities

There are several customer segments/profiles that line up well for one or both products. Recognizing these profiles can streamline your decision-making process when recommending these products to your prospects:

• Young professionals - long-term growth and protection. Clients in their 20s and 30s who are looking for both protection and the potential for growth.
• Middle-aged - wealth preservation. Clients in their 40s and 50s who are looking to preserve wealth, minimize tax burdens and ensure a stable retirement.
• Retirees - reliable income. Clients in their 60s and beyond who need a dependable income stream and have a fear of losing their hard-earned nest egg.

Let’s explore these three scenarios to illustrate when an IUL or an annuity might be the best fit for your clients.

Scenario 1: Young professional planning for retirement

Meet Sarah, a 30-year-old with a stable career and long-term financial goals. For her financial situation, she’s looking to build her retirement savings while also providing financial security for her family.

• Why IUL? Sarah values flexibility and potential growth. She is already following her financial advisor's advice on maximizing her employer's contribution to her 401(k). In this example, an IUL provides her with life insurance protection for her young and growing family while also allowing her to diversify her savings and leveraging cash value to grow over time, which she can tap into for future needs. The market-linked growth potential without direct exposure suits her moderate risk tolerance while allowing her to increase her total percent of income she’s saving each month.
• Why not an annuity? Although an annuity could provide future income, Sarah’s current focus is on growth and flexibility instead of securing a fixed income stream. On top of that, she has the time horizon to capture more market growth with traditional investments that carry a higher risk. If she keeps up her pace with savings, a future savings rollover to an annuity isn’t out of the question. It could be a great vehicle for her to transition her accumulation mindset to a preservation mindset in retirement.

Scenario 2: Middle-aged individual focused on wealth preservation

James is a single, 50-year-old man with significant savings. He aims to preserve his wealth and minimize tax exposure while planning for retirement.

• Why IUL? James benefits from the tax-deferred growth and the ability to use the policy’s cash value as a supplemental retirement income source that isn’t capped like his 401(k). The death benefit also ensures a legacy for his heirs, which aligns with his estate planning goals.
• Why an annuity? James is approaching his final 10-12 highest earning years and understands the value of protecting his hard-earned savings while still working towards his retirement goals. In this case, James can roll a percentage of his existing savings into a fixed annuity which removes risk of market downturns while also allowing for predictable growth that aligns with his goals during his last decade or so of working. This strategy allows him to diversify his risk while still focusing on growth.

Scenario 3: Retiree seeking reliable income

Linda, a 65-year-old, active and healthy retiree, requires a consistent income to supplement Social Security and support her living expenses throughout retirement.

• Why an annuity? Linda’s priority is guaranteed income that she won’t outlive. An annuity offers her a predictable and stable income stream, which is crucial at her stage of life. It reduces the risk of outliving her savings and provides peace of mind. In this instance, she would likely benefit from a single premium immediate annuity, which allows her to fund her annuity in a lump sum and begin taking her income immediately. If she can wait a few years before needing her supplemental income, she can consider a fixed indexed annuity. This offers an income rider which could potentially increase her supplemental income. The good news is she has options.
• Why not IUL? This is a perfect example where insurance agents can create a bad name for themselves. Regardless of how an IUL illustration can be manipulated, its cash value growth is too slow to meet Linda’s immediate income needs. The ongoing premiums paired with the cost of insurance at her age doesn’t make an IUL a proper fit for Linda’s situation.

Tailoring your recommendations to your client’s financial future is critical. Whether an annuity or an indexed universal life insurance policy is the right fit will depend on your client’s financial goals, life stage and risk tolerance.

Here is one simple question you can ask clients to get the discussion moving in the right direction: Do you want/need income now or later?

Knowing the answer to that question will help you properly navigate your prospect’s needs and open up additional questions to help you work together to find the right solution and build lasting, trust-based relationships.

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Drew Gurley is a licensed life insurance expert with nearly 15 years of experience. During his career as both a licensed life insurance agent and industry executive he has helped thousands of clients with their life insurance needs through his work at Redbird Advisors and Senior Market Advisors.