The Roth 401(k) vs the IUL

But how can we be certain? A surefire way to determine the least expensive alternative is to perform a side-by-side comparison where you contribute equal amounts of money to both programs over a fixed time period (say 10 years). Next, distribute tax-free dollars from both programs for another fixed time period (say 25 years) starting in year 11. Be sure to apply the 1.5 percent expense ratio to the Roth 401(k) while letting the life insurance illustration system account for the internal expenses of the IUL. 

In most cases, you'll find the IUL can distribute tax-free dollars just as productively as the Roth 401(k). Equal distributions, by definition, mean equal fees. In fact, when you run the internal rate of return (IRR) on a properly structured IUL, you'll find that its annual expenses, averaged out over the life of the program, are around 1.5 percent.

The moral of the story: Whether you put your money into a Roth 401(k) or an IUL, someone is going to be making 1.5 percent. The real question is, what are you getting in exchange for that 1.5 percent? In the case of the Roth 401(k), you're getting money management, third party administration and advisor fees. By the way, you pay those fees rain or shine, even in a down market. In the case of the IUL, you are paying 1.5 percent of your account value on average over the life of the program, but you're getting something very useful and impactful in exchange for it. 

Upside market potential with downside protection 

For starters, the IUL allows you to participate in the upward movement of a stock market index while guaranteeing against market loss. To illustrate how powerful this is, I ask my clients the following question: "If you lost 50 percent in your Roth 401(k) this year, what would you have to accumulate next year, just to break even?" Nine times out of ten, they say 50 percent. The truth is they'd have to get 100 percent just to get back to square one. For those who lost 50 percent in 2008, it took them an astounding six years just to claw their way back to even. The guarantees in the IUL can safeguard your clients against market loss at a period in their life when they can least afford to take the hit: at retirement. Many IULs have back tested rates of return of nearly 8 percent. After netting out the 1.5 percent average fee, that's a 6.5 percent rate of return. If your clients can get a 6.5 percent rate of return without taking any more risk than they're accustomed to taking in their savings account, that can be a very safe and productive way to grow their money.

A life insurance death benefit

That 1.5 percent average annual expense in an IUL also goes towards the cost of life insurance. Many of our clients have already budgeted for the cost of term insurance. Instead of sending that term insurance premium off to an insurance company in the form of a premium payment, why not recapture it, divert it towards their IUL bucket, then let a portion of it drip out in the form of expenses? In other words, when our clients pay for the cost of term insurance, they're paying for much of the cost of an IUL, they're just not taking advantage of the unlimited bucket of tax-free savings the IUL affords them. The tax-free life insurance component of the IUL is one of the great benefits that 1.5 percent fee provides.

Doing double duty: life insurance as long-term care     

There's one final benefit that clients get in exchange for that 1.5 percent cost: long-term care. Most IUL companies these days allow the tax-free death benefit to double as long-term care insurance at no additional charge. The stipulation is this: If somewhere down the road you can no longer perform two of six activities of daily living, and can find a doctor to write a letter to that effect, they will give you your death benefit while you're alive, for the purpose of paying for long-term care. Contrast this with traditional long-term care insurance where you could pay for 20 years, die peacefully in your sleep never having needed it, and then never get your money back. With IUL, you do pay the cost of insurance, but if you die never having needed long-term care, your heirs still receive a death benefit. So, there isn't the heartburn associated with paying for something you hope you never have to use.