What if you had access to a life insurance policy that was flexible and so that you could adjust the life insurance premiums and face value and even have the ability to increase cash value—would that be important to you?
And, what if you could get this type of policy without the built-in drawback that is often a part of investing in the equities market? Well, you can. It’s called an indexed universal life insurance policy (IUL). These policies are certainly not for everybody, so continue reading to find out if this conjunction of flexibility and growth is a good solution for you. Here we’ll discuss the pros and cons of Indexed Universal Life Insurance.
About Universal Life Insurance
Universal life insurance is available in a few different policy forms, from fixed-rate types to variable types, where you choose assorted equity accounts to invest a portion of your premium in. Indexed universal life (IUL) allows the policyholder to assign cash value amounts to either a fixed account, an equity index account or both.
The IUL offers you a variety of popular indexes such as the S&P 500 or the Nasdaq 100. IUL policies are more unpredictable than fixed ULs, but much less risky than variable universal life policies because your money is actually invested in equity positions rather than directly in the market.
IULs offer tax-deferred accumulation of your cash value for your retirement while preserving a death benefit. Individuals who want permanent life insurance coverage but also want to take advantage of potential cash accrual via an equity index could very well use IULs as key person insurance for business owners, premium financing plans or estate-planning solutions. IULs are referred to as advanced life insurance policies in that they can be complicated to effectively explain and comprehend.
How does an Indexed Universal Life Insurance Policy Work?
With Indexed Universal Life Insurance, when your premium is paid, a part of that premium pays for annual renewable term insurance based on the insured’s life expectancy. Any fees are also deducted and then the remainder is added to the cash value account. The total cash value account is then credited with interest determined by any increases in an equity index (but never invested directly in the stock market). Some IULs permit the policyholder to pick multiple indexes. IULs usually come with a minimum fixed interest and a choice of indexes. Policyholders can determine the percent allocated to the fixed and indexed accounts.
The value of the chosen index is reported at the start of the month and then compared to the value at the end of the month. If during the month, the index increases, the interest is added to the cash value account. The index gains are credited back to the policy either on a monthly or yearly basis.
For instance, if your selected index gained 6% from the beginning of June to the end of June, the cash value is multiplied by the 6% gain. The resulting interest is added to the cash value. Some IUL policies compute the index gains as the sum of the changes for the period while others take an average of the daily gains for a month. If the index goes down during for that month, no interest is credited.
The gains realized in an index are credited to your policy based on a percentage rate, which is known as the participation rate. The rate is set by the insurance company so it’s important to understand the specified rates before you buy. The rate can be anywhere from 25% to more than 100%.
For example, if the gain is 8%, and the participation rate is 50% and the current cash value total is $10,000, $400 is added to the cash value in your policy (8% x 50% x $10,000 = $400).
Indexed Universal Life Insurance policies typically credit the index interest to cash accumulations on an annual basis or once every five years.
What are the Pros of Indexed Universal Life Insurance?
- The rates are generally lower since policy owner is accepting the risk.
- Cash value that accumulates on a tax-deferred basis and when sufficient will allow the policy owner to reduce or skip premium payments.
- Flexibility: The policy owner keeps control of the amounts at risk in the indexed accounts versus a fixed account and the death benefit can easily be changed to accommodate life events. Most policies in the market today also offer several optional riders like guaranteed death benefit and no-lapse guarantees.
- The death benefit in the Indexed Universal Life policy is permanent and not subject to taxes.
- Since the premium dollars are not invested in the stock market directly, the policy presents a lower risk to the policy owner.
- Cash Access: Your accumulated cash in the policy can easily be accessed without penalties through policy loans, partial surrenders, or full surrender regardless of the policy owner’s age.
- Unlike other investment products, there are no contribution limits on an Indexed Universal Life policy.
What are the Cons?
- The insurance company will set a cap on the participation rate that can be less than 100%
- Small face amount policies generally do not perform any better than a traditional Universal Life policy.
- If the equity index goes down, typically no interest is credited to the cash value however the policy does have a floor so your money will not be lost in a down market.
The Bottom Line
Although the IUL is not for everybody, it is certainly a viable option for individuals who want the security of a traditional fixed UL policy and the increased potential to earn interest from the index accounts.