IUL Retirement Planning: Reducing Investment Risk Near Retirement

IUL retirement planning may provide an additional way to manage financial risk as retirement approaches. When we are young, we generally have more time to recover from market downturns. A decline can still be unsettling, but an investor with several decades before retirement may be able to keep contributing, buy investments at lower prices, and wait for a possible market recovery.

The situation changes as retirement gets closer. A market decline at age 35 is not necessarily the same financial event as a decline at age 65. Someone approaching retirement has fewer working years available, may no longer be making regular contributions, and may soon need to withdraw money for living expenses.

This creates an important retirement-planning challenge: How can we continue pursuing enough growth to support a long retirement while reducing the possibility that a poorly timed market decline disrupts our income?

Diversification, suitable asset allocation, cash reserves, Social Security, pensions, annuities, and insurance strategies may all play a role. For certain individuals, IUL retirement planning may add another source of financial flexibility to the overall strategy.

An indexed universal life insurance policy cannot eliminate investment risk, guarantee retirement income, or replace a diversified portfolio. However, its accumulated cash value may provide a source of funds that is not directly invested in the stock market. Under appropriate circumstances, that cash value may reduce the immediate need to sell market-based investments during an unfavorable period.

IUL retirement planning is most effective when it supports a broader financial strategy built around investments, insurance protection, liquidity, and dependable sources of income.

Investment risk during our younger years

Younger investors often possess an advantage that cannot be purchased later: time.

Imagine a 30-year-old who expects to retire at 67. This person has approximately 37 years remaining before reaching the planned retirement date. During that time, the investor will probably experience multiple market corrections, recessions, and periods of financial uncertainty.

A younger investor may be able to respond to a downturn by continuing regular retirement contributions. When prices are lower, those contributions may purchase more shares. If the market eventually recovers, shares acquired during the decline can participate in that recovery.

This does not mean stocks become safe simply because someone holds them for a long time. According to FINRA’s investment-risk guidance, investments can lose value, and a longer holding period does not eliminate the possibility of loss.

Nevertheless, a longer time horizon generally provides more opportunities to recover from volatility. Younger investors with stable income, emergency savings, gs and an appropriate risk tolerance may choose to allocate more of their retirement savings to growth-oriented investments.

A younger person still needs a strong financial foundation. That foundation may include:

• Maintaining an emergency fund
• Managing high-interest debt
• Contributing to an employer-sponsored retirement plan
• Taking advantage of an available employer match
• Maintaining appropriate health and disability coverage
• Protecting dependents with suitable life insurance
• Diversifying investments
• Planning for short- and long-term financial goals

People evaluating protection for their families can review the Gibbs Insurance overview of available life insurance options.

Why investment risk changes near retirement

Now consider a 62-year-old who expects to retire at 65. This person may have accumulated substantial savings but has only three working years remaining before the planned retirement date.

A major market decline could affect more than the balance on an account statement. The investor may be preparing to replace a regular paycheck with withdrawals from retirement accounts. There may not be enough time to wait several years for a full recovery.

The consequences become more serious if the investor must sell assets while their values are depressed.

During the accumulation stage, a person generally contributes to retirement accounts. During retirement, the direction reverses. The retiree begins taking money out. If withdrawals occur while the portfolio is declining, more shares may need to be sold to produce the same amount of income.

Those shares are then unavailable to participate in a future recovery.

As retirement approaches, FINRA recommends reassessing portfolio risk, in part because the investor may have less time to recover from a major decline.

This is one reason IUL retirement planning may become more relevant as someone moves from accumulating assets to using those assets for income. The objective is not to abandon market investments. It is to consider whether an additional financial resource could provide flexibility during periods of volatility.

Understanding sequence-of-returns risk

Sequence-of-returns risk refers to the possibility that poor investment results will occur at an especially damaging time, such as shortly before or after retirement begins.

Consider two hypothetical retirees who start with identical portfolios and withdraw the same amount each year. Over 20 years, both portfolios experience the same average annual return. However, the first retiree receives positive returns during the early years, while the second experiences substantial early losses.

Even if the return patterns later reverse, the second retiree may end with considerably less money. Early withdrawals combined with early losses reduce the principal available to participate in a later recovery.

This is why retirement risk is not measured only by a portfolio’s average return. The order in which positive and negative returns occur can also influence how long the money lasts.

Sequence risk can be especially important during the years immediately before and after retirement. A significant loss during this period may force someone to:

• Delay retirement
• Reduce planned spending
• Withdraw a larger percentage of the remaining portfolio
• Sell investments at depressed prices
• Return to work
• Reduce the legacy intended for beneficiaries

No retirement strategy can control future market performance. A well-constructed plan should therefore consider how income needs could be met if a downturn arrives at an inconvenient time.

IUL retirement planning may provide one possible response to sequence risk by creating an additional source of accessible policy value. However, it must be coordinated with the retiree’s investments, cash reserves, income needs, and insurance objectives.

Traditional strategies for reducing retirement risk

IUL retirement planning should be evaluated alongside traditional risk-management strategies, not used automatically in place of them.

Adjusting asset allocation

As retirement approaches, some investors gradually reduce their exposure to volatile assets and allocate more money to bonds, cash,h or relatively stable holdings.

This does not remove risk. Bonds can decline, and cash may lose purchasing power because of inflation. An excessively conservative portfolio may also fail to produce enough growth for a retirement lasting 20 or 30 years.

The objective is to establish a suitable balance among growth, stability, liquidity, and income.

Maintaining a cash reserve

Some retirees maintain enough cash or short-term reserves to cover a portion of their expected expenses. During a market decline, they may draw from that reserve rather than immediately selling long-term investments.

Cash reserves eventually need to be replenished, and maintaining too much cash may reduce long-term growth. Nevertheless, a carefully planned reserve can provide valuable flexibility.

Diversifying retirement income

Retirement income may come from Social Security, a pension, retirement accounts, taxable investments, rental property, an annuity, business interests, or life-insurance cash value.

Income sources that respond differently to market conditions may reduce dependence on any single account.

Using flexible withdrawals

Retirees who can reduce discretionary expenses after an unfavorable market year may be able to limit portfolio withdrawals temporarily. This can help preserve assets, although many households have essential expenses they can’t reduce.

Working longer

Continuing to work may allow someone to save more, delay portfolio withdrawals, and possibly postpone Social Security benefits. Health, employment opportunities, and family responsibilities can make this strategy unavailable.

IUL retirement planning may complement these techniques by providing another potential source of funds. It should not be viewed as a reason to ignore diversification, liquidity, or careful withdrawal planning.

How IUL Retirement Planning Works

Indexed universal life insurance is a form of permanent life insurance. Its primary purpose is to provide a death benefit, subject to the terms of the contract and the payment of sufficient premiums.

The National Association of Insurance Commissioners identifies indexed universal life as one of several forms of life insurance available to consumers.

An IUL may also accumulate cash value. Interest credits are calculated partly by reference to the performance of an external market index. The policyowner does not directly invest in that index or own the stocks included in it.

With IUL retirement planning, the crediting method, policy expenses, and long-term funding assumptions are just as important as the selected index.

The index-crediting floor

Many IUL crediting strategies include a floor, commonly 0%, for an index-crediting period. If the selected index declines, the calculated index credit may be zero rather than negative.

The floor does not mean the policy’s total cash value cannot decline. Insurance expenses and other policy charges continue to be deducted. Cash value may therefore decrease even when the index credit is 0%.

This distinction is essential when evaluating IUL retirement planning. A floor offers protection within the index-crediting formula, but it does not guarantee that the policy’s net cash value will never decrease.

The cap

A cap limits the index gain used in the interest-crediting calculation. If an index rises by 15% and the applicable cap is 9%, the calculation would generally use no more than 9%, subject to the policy’s other provisions.

Caps may not be guaranteed for the life of the contract. The insurer may have the right to change them within stated limits.

The participation rate

A participation rate determines how much of an index gain is included in the calculation. For example, a 70% participation rate applied to a 10% index gain would produce a 7% result before other limitations and policy charges.

Some crediting strategies use a participation rate, a cap, or a spread. Others use a combination of features.

Policy expenses

An IUL normally includes insurance charges, administrative expenses, and other deductions. Insurance costs may increase as the insured person gets older.

These expenses mean that a 0% index credit is not the same as a year with no reduction in cash value.

A sound IUL retirement planning analysis should evaluate how expenses affect the policy under both favorable and unfavorable crediting assumptions.

How IUL Retirement Planning May Reduce Withdrawal Risk

The potential retirement value of an IUL does not depend on outperforming the stock market. It comes from establishing another possible source of accessible funds.

Suppose a retiree experiences a significant market downturn during the first few years of retirement. Selling investments after a decline could intensify sequence-of-returns risk.

If the retiree owns a properly funded IUL with sufficient available cash value, the retiree may be able to access some policy value through withdrawals or loans. Those funds could potentially cover a portion of current expenses, reducing the amount that must be sold from market-based investments.

This may give the investment portfolio more time to recover.

The potential advantage of IUL retirement planning is having another source of funds when selling market investments may be undesirable. Taking a policy loan does not guarantee a better financial result.

Withdrawals and loans reduce available policy value and generally reduce the death benefit. Policy loans also accrue interest. Excessive distributions may cause the policy to require additional premiums or lapse.

A successful IUL retirement planning strategy therefore requires appropriate funding, conservative assumptions, and regular policy reviews.

A hypothetical retirement example

Consider Michael and Dana, a hypothetical couple preparing to retire. This composite example does not represent actual clients or a guaranteed result.

Michael and Dana have retirement accounts, cash reserves, anticipated Social Security benefits, and an IUL purchased many years earlier to address a permanent life-insurance need. They funded and reviewed the policy consistently, allowing it to accumulate accessible cash value.

Two years after retiring, the market declines substantially. Their regular living expenses have not changed, but their investment accounts are temporarily worth less.

They could continue taking all their planned withdrawals from the investment portfolio. Doing so, however, would require selling more shares while market prices are depressed.

Instead, they consult their financial, insurance, and tax professionals. Together, they consider:

• Drawing from their cash reserve
• Temporarily reducing discretionary spending
• Taking a smaller investment-account withdrawal
• Accessing a limited amount of IUL cash value
• Combining several approaches

After reviewing the policy and other alternatives, they determine that accessing a limited amount of policy value may reduce the number of investments they must sell that year.

This IUL retirement planning decision does not guarantee a better outcome. The market could decline further, and the loan will need to be monitored. Michael and Dana have created another potential option at a time when flexibility may be valuable.

IUL Retirement Planning Does Not Eliminate Risk

It would be misleading to describe an IUL as a market investment without downside risk. An IUL is a life-insurance contract with its own expenses, limitations, and risks.

The policy’s cash value is not directly invested in the stock market, and an index-crediting floor may prevent a negative index credit. In exchange, the policyowner gives up some potential upside through caps, participation rates or spreads and accepts other risks, including:

• Policy expenses
• Increasing insurance costs
• Changing nonguaranteed terms
• Lower-than-illustrated interest credits
• Loan interest
• Surrender charges
• Policy lapse
• Insurer claims-paying risk
• Possible tax consequences

IUL retirement planning changes the combination of risks a person accepts; it does not eliminate financial risk.

Some direct market exposure is exchanged for insurance-contract risk, policy-performance risk, and reduced upside potential. Consumers should understand this trade-off before purchasing a policy.

Policy illustrations are not promises.

An IUL illustration demonstrates how a policy might perform under selected assumptions. It is not a promise of future results.

Actual performance may differ because of:

• Lower index credits
• Changes to caps or participation rates
• Policy expenses
• Missed or reduced premiums
• Withdrawals
• Policy loans and loan interest
• Death-benefit changes
• Policyowner behavior

Review both the guaranteed and nonguaranteed values. It may also be helpful to request alternative illustrations using lower crediting assumptions.

Conservative illustrations can help determine whether an IUL retirement planning proposal remains sustainable under less favorable conditions.

If the proposed strategy works only when the policy consistently earns favorable nonguaranteed credits, it may not contain a sufficient margin for error.

Understanding withdrawals and policy loans

Policy withdrawals generally reduce cash value and may reduce the death benefit. Withdrawals that exceed the policyowner’s tax basis may have tax consequences, depending on the contract and applicable law.

A policy loan is not the same as withdrawing earnings from a savings account. The insurer lends money using policy value as collateral, and interest accrues under the policy’s loan provisions.

Outstanding loans generally reduce available policy value and the death benefit. Excessive loans can cause a policy to require additional premiums.

If a policy lapses or is surrendered with a substantial outstanding loan, the owner could face unexpected taxable income. The IRS explains the general tax treatment of surrendering a life-insurance policy, including situations in which proceeds exceeding the owner’s investment in the contract may be taxable.

Any IUL retirement planning distribution strategy should account for loan interest, reduced policy values, and the possibility of lapse.

Tax rules are complex and can change. A qualified tax professional should review the proposed distribution strategy.

Why starting earlier may help

An IUL is generally designed as a long-term contract. The early years may include insurance expenses and surrender charges, and accessible cash value may initially be limited.

Starting earlier may provide more time to:

• Spread premiums over a longer period
• Accumulate policy value
• Absorb early policy expenses
• Adjust funding if performance is lower than expected
• Address insurability while younger
• Build a more substantial source of potential flexibility

Starting early does not make an unsuitable policy appropriate. Someone should not begin IUL retirement planning without first considering emergency savings, debt, workplace benefits, and immediate protection needs.

It may also be unwise to give up an employer retirement-plan match solely to fund life insurance. Financial priorities must be evaluated together.

Who Should Consider IUL Retirement Planning?

IUL retirement planning may be worth evaluating when a person:

• Has a genuine need for permanent life insurance
• Wants long-term death-benefit protection
• Has stable income and adequate emergency savings
• Can consistently fund the policy
• Has a long time horizon
• Understands that illustrated performance is not guaranteed
• Wants another potential source of retirement flexibility
• Can accept surrender restrictions
• Is willing to review the policy regularly
• Understands the policy’s expenses and limitations

The suitability of IUL retirement planning depends on the individual’s insurance needs, resources, health, age,e and expected holding period.

An IUL may be inappropriate for someone who:

• Primarily needs temporary insurance
• Has unstable cash flow
• Needs short-term access to the premiums
• Expects unlimited market participation
• Wants guaranteed investment results
• Cannot maintain the proposed funding
• Is unwilling to review the policy
• Does not have a meaningful permanent-insurance need

Term insurance combined with separate investing may be more appropriate for many families. Whole life, traditional universal life, annuities, and other strategies may also deserve consideration.

Before implementing IUL retirement planning, compare the proposed policy with both insurance and non-insurance alternatives.

Questions to ask before purchasing an IUL

Before purchasing a policy, ask:

1. What permanent life-insurance need does this policy address?
2. How much premium is planned?
3. How long are premiums expected to be paid?
4. What happens if a premium is missed or reduced?
5. Which policy values are guaranteed?
6. Which values depend on nonguaranteed assumptions?
7. What are the current caps, participation rates, and spreads?
8. Which policy terms can the insurer change?
9. What insurance and administrative charges apply?
10. How long does the surrender-charge period last?
11. How would lower interest credits affect the policy?
12. How do withdrawals affect cash value and the death benefit?
13. What interest rate applies to policy loans?
14. What could cause the policy to lapse?
15. What happens if it lapses with an outstanding loan?
16. Could the funding create a modified endowment contract?
17. How often will the policy receive an in-force review?
18. Which alternatives were considered?
19. What compensation does the insurance professional receive?
20. What is the financial strength of the issuing insurer?

A professional IUL retirement planning review should answer these questions using the actual policy contract and current illustration.

Building a Balanced IUL Retirement Planning Strategy

An IUL should not be treated as a substitute for every other retirement resource. It may complement a diversified financial strategy that includes:

• Employer-sponsored retirement accounts
• Traditional or Roth IRAs
• Taxable investments
• Cash reserves
• Social Security
• Pension benefits
• Bonds and other income-producing assets
• Annuities when appropriate
• Real estate or business income
• Health and long-term-care planning
• Permanent life insurance

Different assets and products serve different purposes. Investments may provide long-term growth. Cash provides liquidity. Social Security and pensions may provide regular income. Life insurance provides a death benefit and may accumulate accessible policy value.

The purpose of IUL retirement planning is not to identify one product that does everything. The objective is to coordinate multiple resources so the strengths of one can balance the limitations of another.

Regular policy reviews are essential.

An IUL is not a “set it and forget it” product. Regular in-force reviews should examine:

• Current cash value
• Current death benefit
• Premiums paid
• Future planned premiums
• Actual interest credits
• Current caps and participation rates
• Policy charges
• Outstanding loans
• Accrued loan interest
• Updated policy projections
• Changes in insurance needs
• Changes in retirement goals

When underperformance is identified early, the owner may have more options. Depending on the policy, corrective action could include adjusting premiums, reducing planned distributions, repaying a loan,n or revising the death benefit.

Ongoing monitoring is a fundamental part of responsible IUL retirement planning. Waiting until a policy is close to lapsing can make corrective action harder and more expensive.

The bottom line

Investment risk does not disappear as we age. Instead, its potential effect on our financial lives changes.

Younger investors may be able to tolerate more volatility because they have time, future earnings, and continued contributions. People approaching retirement face a different challenge: a major loss may occur just as they begin depending on accumulated assets for income.

A thoughtful strategy should pursue sufficient growth while also creating liquidity and flexibility. It should consider where income will come from during both favorable and unfavorable market conditions.

For an appropriate individual, IUL retirement planning may provide another potential source of funds during a market downturn. Its index-crediting floor can limit direct exposure to negative index performance within the crediting formula. Accumulated policy value may also reduce the immediate need to sell market-based investments.

However, IUL retirement planning does not eliminate risk or guarantee gains. Policy expenses, caps, participation rates, surrender charges, loan interest, and lapse risk must all be considered.

The goal should not be to chase the highest illustrated return. It should be to build a resilient financial strategy that can adapt as needs and investment risks change.

To explore permanent coverage and available policy options, visit the Gibbs Insurance life-insurance information page. You can also learn more about Jay Cohen’s insurance experience.

When you are ready, contact Gibbs Insurance & Financial Services to request a personalized policy and retirement-strategy review.

This article provides general educational information and is not individualized investment, insurance, legal,l or tax advice. Indexed universal life policies contain expenses, limitations, and risks. Nonguaranteed values may perform differently from policy illustrations. Policy guarantees depend on the claims-paying ability of the issuing insurer. Consult qualified professionals before purchasing a policy or implementing a retirement-income strategy.