Outsmart Volatility: Securing Your Retirement with Index Universal Life

Planning for a financially secure retirement has never been more challenging. Market volatility, rising inflation, and unforeseen life events can all disrupt even the best-laid plans.

Yet, there’s a powerful solution that can help insulate your savings from these risks: Index Universal Life (IUL).

In this post, we’ll explore how IUL provides tax-advantaged growth, protects against market downturns, and helps you manage sequence of returns risk so you can retire with greater confidence. 

Understanding the Basics: What Is an Index Universal Life Retirement Strategy?

Key Elements of Index Universal Life (IUL)

An Index Universal Life retirement strategy is built on a life insurance policy designed to accumulate cash value. The policy credits interest based on the performance of a market index (like the S&P 500). Unlike a traditional Discretionary Fund Management (DFM) portfolio directly invested inequities, bonds or funds, an IUL offers:

• Upside potential and downside protection: Gains are tied to a stock market index, but a contractually guaranteed floor mitigates losses.‍
• Flexible premiums: You can adjust premium payments within certain limits.‍
• Tax advantages: Growth within the policy may be tax-deferred, and tax-deferred IUL distributions via policy loans or withdrawals can be used during retirement.‍
• Legacy component: A death benefit passes to your heirs, which in many cases is tax-free

The Value of Tax-Advantaged Cash Value Growth

One of the main attractions of an IUL is its tax-advantaged cash value growth. The policy's cash value compounds on a tax-deferred basis rather than paying taxes each year on dividends or gains, as might be the case with a traditional brokerage account. When it’s time to take distributions, structured policy loans or withdrawals can often be accessed free of income tax, assuming the policy is appropriately managed.

The Power of Zero-Floor Protection for Retirement Planning

How the Zero Percent Floor Works

Zero-floor protection for retirement planning is a defining feature of an IUL. In years when the index experiences negative returns, the interest credited to your policy’s cash value is never lower than zero per cent. This ensures that while you may not receive a positive credit in a down market, you also are not credited with a negative rate. The net effect is a built-in defence mechanism against market downturns. While fees and insurance charges still apply, your cash value does not experience the same immediate volatility that a typical investment might face in a bear market. This protective floor can help enhance the overall stability of your risk-managed retirement portfolio.

Why This Matters for Retirees

Especially in the early retirement years, a severe market decline can wreak havoc on a portfolio. This phenomenon, known as sequence of returns risk, may reduce the lifespan of your savings if you need to withdraw funds during a market slump. By mitigating negative returns via the zero-floor provision, an IUL helps stabilise the cash value and reduces the risk of large drawdowns, preserving more assets for future income generation.

Minimising Sequence of Returns Risk with a Risk - Managed Retirement Portfolio

Understanding Sequence of Returns Risk

A sequence of returns risk arises when an investment portfolio suffers significant losses in the initial years of retirement. Early withdrawals alongside continuous drawdowns can hinder an investor's ability to recover, even during a market upswing later. Two critical factors worsen losses:‍

• Asset Value Decline: If markets fall, your investments lose value.
• Systematic Withdrawals: You may have to sell investments at depressed prices to meet living expenses, permanently locking in losses.

How an IUL Tackles This Challenge

In an IUL, annual crediting is based on an index’s performance but comes with zero-floor protection for retirement planning. This mechanism prevents your cash value from suffering the same drawdowns that affect direct equity and bond investments. While the upside is usually capped or subject to a participation rate, avoiding deep losses in negative years contributes to amore stable retirement income source.

This stability makes an IUL a solid component of a risk-managed retirement portfolio, particularly when combined with other assets like bonds, equities, and annuities. The goal is to strategically diversify so that various assets complement each other, reducing the probability of running out of money.

How IUL Outperforms Normal DFM Portfolios in Certain Markets

Why Sequence Returns Are Generally Lower with an IUL

Zero-Floor Shield: Market downturns do not directly translate to negative crediting.

Annual Reset: The policy’s cash value receives an 'annual reset' securing gains for the following crediting cycle.

Reduced Volatility: With fewer massive drawdowns, the cash value experiences a smoother growth curve, making planning and budgeting retirement income easier.

Retirement Income Diversification: Which Investment Strategy?

Total Return vs. Income Investing

When it comes to retirement, retirees typically take one of two approaches to retirement:

• Total Return Strategy: This strategy focuses on the portfolio's overall growth and relies on systematic withdrawals, including capital gains and dividends
• Income Investing: Seeks to generate sufficient income from dividends, interest, and other steady cash flow sources, ideally avoiding the need to draw down on capital.

Both methods can produce comparable outcomes but differ in execution and investor psychology.‍

How IUL Bridges the Gap

Rather than generating income from owned assets, like stocks paying dividends or bonds paying yields, an Indexed Universal Life (IUL) policy links credited returns to the positive performance of a market index while providing a protective floor against losses. This means policyholders can participate in market gains without experiencing the downside of actual market ownership. Because the returns are credited to the policy (and not derived from physically holding assets), IUL can complement total return and income-based retirement plans, making it an appealing addition to a diversified retirement strategy.

Addressing Volatility with a Volatility Buffer in Indexed Life Insurance

What Is a Volatility Buffer?

A volatility buffer with indexed life insurance refers to the stabilising effect that an IUL provides through its zero-floor protection. Rather than having your entire retirement contingent on market performance, theIUL’s cash value has built-in features that help it weather downturns. This buffer can reduce stress on your broader portfolio by limiting your reliance on investments subject to unpredictable price swings.

Integrating the IUL Buffer into a Comprehensive Plan

• Cover Shortfall in Down Years: If other investments are facing a downturn, you could temporarily rely on your IUL’s cash value for income, avoiding the need to sell stocks or bonds at a loss.
• Promote Portfolio Growth: By not tapping market-dependent assets in poor market years, those assets can remain invested, potentially benefiting from future rebounds.
• Retire with Greater Confidence: Knowing you have a cushion against market volatility can improve peace of mind and reduce the likelihood of panic-driven decisions.
• Higher Risk Assets for Higher Returns:With an IUL as part of your retirement income strategy, providing a lower risk core, you can afford to invest in higher risk and potentially higher return assets.

Practical Steps to Incorporate an IUL into Your Risk - Managed Retirement Portfolio

1. Assess Your Financial Goals and Needs

Start by estimating your long-term retirement income requirements. Look at existing resources like pensions, discretionary managed portfolios, state pensions, and other potential sources of retirement income, such as property rentals. Identify the income shortfall (if any) and determine if an IUL could help fill that gap.

2. Evaluate Policy Structures

Every IUL product has varying caps, participation rates, and cost structures. Collaborate with a qualified insurance professional to compare policies and tailor the design to your specific financial profile.

3. Fees

While the upside potential and downside protection are attractive, IULs have administrative costs, insurance charges, and potential surrender fees. Ensure these costs are understood. You can also compare them with other investments like the fees for running a discretionary investment portfolio managed service or a property rental.

4. Monitor, Review, and Adjust

An IUL policy is not a ‘set it and forget it’ solution. Adjust coverage amounts, premium contributions, and withdrawal schedules as your situation evolves. Consider running annual or biannual reviews with your advisor.

5. Consider Pairing with Other Strategies

Holding a mix of investments, such as stocks, bonds, annuities, and an IUL, can benefit retirement income diversification. This combination can reduce portfolio volatility while maximising tax advantages, lowering risk, and maintaining potential growth.

The Bottom Line: Combining Total Return and Income Strategies for a Secure Retirement

Index Universal Life insurance offers a unique blend of growth opportunity and protection, making it a compelling option for individuals seeking a risk-managed retirement portfolio. By providing zero-floor protection for retirement planning, the ability to tap into tax-efficient IUL distributions, and serving as a volatility buffer, an IUL can help you avoid the pitfalls of sequence of returns risk and enjoy a more predictable path toward meeting your retirement goals.

Next Steps: Ready to Explore an IUL?

If you want to bolster your retirement strategy with greater stability and potential tax advantages, consider how an IUL might fit your needs. Get a quote or contact us today for a personalised assessment and find out whether zero-floor protection could be your key to a more confident retirement.

Disclaimer

This article is authored by Carlton Crabbe, Chief Executive Officer of Capital for Life, a specialist indexed universal life insurance broker. The information provided in this article is for educational and informational purposes only and should not be construed as financial or investment advice. While the author possesses expertise in the subject matter, readers are advised to consult a qualified financial advisor before making investment decisions or purchasing life insurance products.