Why Bucket 3 matters
Money in Bucket 3 grows without annual tax and can come out without being counted as taxable income. That matters most in retirement, when every taxable dollar can also raise the tax on your Social Security and your Medicare premiums.
The best-known Bucket 3 tools are the Roth IRA and Roth 401k. They're excellent, but the Roth IRA has income limits, and both have annual contribution caps. Indexed universal life insurance is the other major Bucket 3 tool, and it plays by different rules.
How indexed universal life works
An IUL is permanent life insurance with a cash value account. Part of each premium pays for the insurance, and the rest builds cash value.
- Index-linked interest. Cash value is credited with interest based on the performance of a market index such as the S&P 500. Your money is not invested in the market itself.
- A 0% floor. In a year the index falls, credited interest is 0%, so index losses don't reduce your cash value. Policy charges still come out every year.
- Caps and participation rates. In exchange for the floor, upside is limited by a cap or participation rate set by the carrier, which can change.
- Tax-free access. When the policy is funded and managed properly, you can access cash value through withdrawals up to your basis and policy loans, which are not taxable income under current law.
Zero is Hero. In a year like 2008, when the S&P 500 fell about 37%, an indexed account credits 0% instead of a loss. You don't have to recover from a crash you didn't take. The trade-off: caps also limit your gains in strong years like 2009.
Living Benefits
Many IUL policies include accelerated benefit riders that let you use part of the death benefit while you're alive if you're diagnosed with a qualifying chronic, critical or terminal illness. For many families, that's the difference between a health event and a financial crisis. Riders, costs and qualifying conditions vary by carrier and state.
Roth vs. IUL at a glance
| Feature | Roth IRA | Indexed Universal Life |
|---|---|---|
| Income limits to contribute | Yes | No, but funding is limited by IRS rules on life insurance |
| Market exposure | Depends on investments; can lose value | Index-linked interest with a 0% floor, limited by caps |
| Tax-free access | Qualified withdrawals after 59½ and 5 years | Withdrawals to basis and policy loans, when structured properly |
| Counts toward SS tax and IRMAA | No (qualified withdrawals) | No (properly structured loans and withdrawals) |
| Death benefit | No | Yes, generally income tax free |
| Living Benefits | No | Often available by rider |
| Costs | Fund expenses | Cost of insurance and policy charges, highest in early years |
They aren't rivals. Many of our clients use both.
Who it fits
- Have stable income and can fund the policy for many years
- Want tax-free income that won't trigger Social Security tax or IRMAA
- Earn too much for a Roth IRA, or already max your Roth options
- Want life insurance with Living Benefits anyway
- Need the money back in a few years
- Can't commit to consistent funding
- Don't need or can't qualify for life insurance
- Have high-interest debt and no emergency fund
Structure is everything
An IUL only works as a Bucket 3 tool when it's designed for it. That means the right carrier, a death benefit set to allow strong funding while staying under the IRS limits that would turn it into a modified endowment contract (MEC), and a funding schedule you can actually keep.
- A policy funded too heavily can become a MEC and lose tax-free loan treatment.
- A policy funded too lightly can run out of cash value and lapse. A lapse with a loan outstanding can create a tax bill.
- Loans accrue interest and reduce the death benefit if not repaid.
We review illustrations from multiple carriers at conservative assumptions and revisit the policy every year.
Questions we hear often
Is IUL an investment?
No. It's life insurance with a cash value that earns interest based on an index. It does not directly participate in the stock market, and it has insurance costs an investment account doesn't.
Can I lose money in an IUL?
The 0% floor protects credited interest from index losses, but policy charges come out every year, so cash value can decline, especially in early years or if the policy is underfunded.
How much does it cost?
Costs depend on your age, health, the death benefit and how the policy is designed. We show you the charges in the illustration before you decide.
What is Million Dollar Baby?
Our name for a juvenile IUL concept: a policy started for a child at birth and funded for 18 years, giving them life insurance and a head start on Bucket 3. Values are not guaranteed and illustrations are hypothetical. Ask about it on your discovery call.