Indexed Universal Life Insurance (IUL)
What Is Indexed Universal Life Insurance (IUL)?
Indexed universal life insurance (IUL) is a type of permanent life insurance that offers death benefit protection and the potential for cash value accumulation.
The cash value growth of IUL policies is tied to one or more stock market indexes, providing the policyholder with the potential to participate in upside index performance while being shielded from downside risk.
IUL policies also typically offer a number of living benefits riders that can further increase the policy’s value, including the ability to access cash value through policy loans and withdrawals, as well as the potential to use the death benefit while you are still alive (in the event of a chronic illness or long-term care need).
Universal life insurance is one of two main types of permanent life insurance (the other being whole life insurance).
Unlike whole life, which offers guaranteed level premiums, cash value growth and death benefit protection, universal life provides policyholders with more flexibility in how they structure their coverage.
With universal life insurance, you can choose to pay more or less than the required minimum premium payment each year.
You can also choose to increase or decrease your death benefit coverage as your needs change over time.
And, unlike whole life insurance, the cash value growth of universal life policies is not guaranteed. It will fluctuate based on the performance of the underlying investments.
Indexed universal life insurance combines the best features of both whole life and universal life into one policy.
It offers the potential for cash value growth tied to stock market indexes, as well as the flexibility to make premium payments above or below the required minimum.
And, like whole life insurance, IUL policies offer guaranteed level premiums and death benefit protection.
Indexed Universal Life Insurance: The Basics
Here are some of the key features of indexed universal life insurance:
Guaranteed Death Benefit Protection
The death benefit payout on IUL policies is guaranteed, as long as you continue to pay the required minimum premium payments.
This means that your beneficiaries will receive a death benefit payout regardless of how the stock market performs or how much money is in the policy’s cash value account.
Flexible Premium Payments
You can choose to pay more or less than the required minimum premium each year with an IUL policy.
Paying more than the minimum premium will increase the cash value growth potential of your policy, while paying less may result in a decrease in cash value or even a lapse in coverage.
Potential for Cash Value Growth Tied to Stock Market Indexes
The cash value growth potential of IUL policies is linked to one or more stock market indexes, providing the policyholder with the opportunity to participate in upside index performance while being shielded from downside risk.
Most IUL policies offer a “cap” on how much the cash value can grow in any given year, as well as a “floor” or minimum guaranteed rate of return.
This means that you will never lose money due to poor stock market performance, but you also won’t be able to participate in unlimited upside potential.
However, some IUL policies offer “participation rates” that can provide the policyholder with the potential to earn a higher return on index-linked growth.
Policy Loans and Withdrawals
IUL policies offer the ability to take out loans or make withdrawals from the cash value account, subject to certain conditions.
Most IUL policies will allow you to take out a loan up to the policy’s “loan cap”, which is typically equal to the greater of: (a) the accumulated cash value; or (b) the death benefit minus any outstanding policy loans.
Withdrawals may also be subject to limitations, such as a maximum withdrawal amount per year or a requirement that all withdrawals must be taken first from accumulated cash value before the death benefit can be accessed.
No Social Security Impact
IUL policies are “non-qualified” life insurance policies, which means that they are not subject to the same rules and regulations as “qualified” retirement accounts like 401(k)s and IRAs.
This also means that IUL policy loans and withdrawals are not subject to income taxes or early withdrawal penalties.
Understanding Index Universal Life Insurance (IUL)
How Indexed Universal Life Insurance Works
Now that we’ve covered the basics of IUL policies, let’s take a more in-depth look at how they work.
As we mentioned earlier, IUL policies offer the policyholder the potential to earn index-linked growth on the cash value account while being shielded from downside risk.
This is accomplished through the use of “participation rates” and “caps”.
The participation rate is a percentage that determines how much of the index’s return the policyholder will receive.
For example, if an IUL policy has a participation rate of 70% and the index return for the year is 10%, the cash value account will earn 7% (70% x 10%).
The “cap” is a predetermined limit on how much the cash value can grow in any given year, regardless of the index performance.
So, using the same example above, if the IUL policy has a cap of 8% and the index return for the year is 10%, the cash value account will still only earn 8% for that year.
In addition to caps and participation rates, most IUL policies also have a “floor” or minimum guaranteed rate of return.
This means that even if the stock market falls a lot and the index-linked growth is negative for the year, the cash value account will still earn at least the floor rate.
For example, if an IUL policy has a floor of 0% and the index return for the year is -5%, the cash value account will still earn 0%.
Floors are usually zero with IUL policies.
The final piece of the puzzle is the “spread”.
The spread is basically a management fee.
If an indexed universal life insurance policy has a 2% spread, the cash value will be the gross index return minus the spread.
The spread is important because it represents the “cost” of insurance.
In other words, the higher the spread, the more expensive the policy will be.
Now that we’ve covered how IUL policies work, let’s take a look at some of the potential benefits they offer.
Potential Benefits of Indexed Universal Life Insurance
IUL policies offer a number of potential benefits that make them an attractive choice for many people.
Some of the most popular reasons to buy IUL policies include:
- The ability to participate in upside stock market performance while being shielded from downside risk
- The potential to earn higher returns than traditional fixed annuities
- The ability to access the cash value account through loans or withdrawals without triggering income taxes
- The potential to use the death benefit to cover estate taxes
- The ability to leave a legacy for beneficiaries
Of course, it’s important to remember that IUL policies are not without risk.
Before deciding to purchase an IUL policy, be sure to speak with a financial professional to make sure it’s the right choice for you.
Drawbacks of Indexed Universal Life Insurance
Let’s take a look at some of the potential drawbacks of IUL policies.
Some of the most important things to keep in mind include:
- IUL policies are not guaranteed to perform as well as traditional fixed annuities
- IUL policies may have higher fees than other types of life insurance policies
IUL policies cap their returns, which means there is potential for “missed” upside if the index outperforms the cap.
Indexed Universal Life Insurance vs. Other Types of Life Insurance Policies
The value of an IUL is tied to the performance of a stock or financial benchmark.
There are other types of life insurance policies, as noted below:
Term life insurance
This is the simplest and most affordable type of life insurance. Term life insurance policies provide coverage for a set period of time, typically 10, 20, or 30 years.
Whole life insurance
Whole life insurance policies provide coverage for the policyholder’s entire life.
These policies also build cash value over time, which can be accessed through loans or withdrawals.
Universal life insurance
Universal life insurance policies are similar to whole life policies, but they offer more flexibility in terms of premium payments and death benefits.
Like IUL policies, universal life policies also build cash value over time.
Variable Universal Life (VUL) Insurance
Variable life insurance
Variable life insurance policies are similar to VUL policies, but they offer even more flexibility in terms of investment options for the cash value.
As you can see, there are many different types of life insurance policies to choose from. The best policy for you will depend on your specific needs and goals.
Indexed universal life insurance offers the potential to participate in stock market growth while still providing a death benefit and other potential benefits.
FAQs – Indexed Universal Life Insurance (IUL)
How Does Indexed Universal Life Insurance Work?
Indexed universal life insurance works by crediting cash value growth to the policyholder based on the performance of one or more stock market indexes.
The index-linked cash value growth potential is typically credited to the policyholder on a yearly basis, and will be subject to a “cap” or maximum percentage that the cash value can grow in any given year.
For example, if an IUL policy has a 10% cap and the S&P 500 Index increases by 12% in a given year, the policyholder would only receive a 10% credit to their cash value account.
On the other hand, if the stock market decreases in value, the policyholder’s cash value would not be affected in most cases (though it depends on the policy).
Some IUL policies also offer a “participation rate” that can potentially further increase the cash value growth potential.
What Are the Benefits of Indexed Universal Life Insurance?
IUL policies offer several potential benefits, including:
1. Death Benefit – IUL policies provide a death benefit to your beneficiaries in the event of your passing. The death benefit can be used to help cover final expenses, pay off debts, or create an inheritance for your loved ones.
2. Tax-Deferred Growth – The cash value of an IUL policy grows on a tax-deferred basis, meaning you won’t have to pay taxes on the growth until you withdraw the money from the policy.
3. Tax-Free Withdrawals – You can take tax-free withdrawals from the cash value of your IUL policy up to the amount of premiums you have paid into the policy. This feature can come in handy if you need access to cash in a pinch and don’t want to incur any taxes on the withdrawal.
4. Flexibility – IUL policies offer more flexibility than traditional life insurance policies. You can typically choose how much coverage you need and how long you need it for. Additionally, you can customize your policy to fit your unique financial needs and goals.
5. Living Benefits – Many IUL policies come with living benefits riders that allow you to access the death benefit while you are still alive if you meet certain criteria, such as being diagnosed with a terminal illness. This feature can provide much-needed financial assistance during difficult times.
Indexed universal life insurance policies can provide many potential benefits that can help you meet your financial goals and protect your loved ones. If you are considering purchasing an IUL policy, be sure to speak with a financial professional to see if it is the right fit for you.
What Is the Difference Between Universal Life Insurance and Whole Life Insurance?
Universal life insurance and whole life insurance are both types of permanent life insurance. This means that they provide coverage for your entire life, as long as you continue to pay the premiums.
Both universal life and whole life policies also have a cash value component that grows over time.
However, there are some key differences between these two types of policies that you should be aware of:
1. Universal life insurance policies offer more flexibility than whole life insurance policies. With universal life, you can typically choose how much coverage you need and how long you need it for. Additionally, you can customize your policy to fit your unique financial needs and goals. Whole life insurance policies are more rigid, and typically only offer one death benefit option.
2. Universal life insurance policies have a higher potential growth rate than whole life insurance policies. This is because the cash value of a universal life policy is typically invested in stock or bond indexes, which have the potential to grow at a faster rate than whole life cash values.
3. Universal life insurance policies typically have lower premiums than whole life insurance policies. This is because universal life policies offer more options and flexibility than whole life policies.
4. Universal life insurance policies typically don’t require a medical exam. This means that you can get coverage without having to go through the hassle and expense of a medical exam. Whole life insurance policies usually require a medical exam in order to qualify for coverage.
5. Universal life insurance policies typically have more features and riders than whole life insurance policies. Riders are optional additions that you can add to your policy for an additional cost. Some common riders include accelerated death benefits, waiver of premium, and long-term care riders.
The main difference between universal life insurance and whole life insurance is the amount of flexibility and potential growth that they offer.
Universal life insurance policies offer more options and potential growth than whole life insurance policies, but they also typically have higher premiums.
Summary – Indexed Universal Life Insurance (IUL)
Indexed universal life insurance is a type of permanent life insurance that offers death benefits and cash value accumulation.
IUL policies typically have more flexibility than whole life insurance policies and offer the potential for higher growth.
Additionally, many IUL policies come with living benefits riders that allow you to access the death benefit while you are still alive if you meet certain criteria, such as being diagnosed with a terminal illness.
If you are considering purchasing an IUL policy, be sure to speak with a financial professional to see if it is the right fit for you.