Indexed Universal Life Insurance (IUL)

What Is Universal Life Insurance?

Universal life (UL) insurance comes in many different flavors, from fixed-rate models to variable ones, where you select various equity accounts to invest in. Indexed universal life (IUL) insurance allows the owner to allocate cash value amounts to either a fixed or equity index account. Policies offer a variety of well-known indexes, such as the Nasdaq-100 or the S&P 500.

IUL insurance policies are more volatile than fixed ULs, but they are less risky than variable UL insurance policies because no money is invested in equity positions.

IUL insurance policies offer tax-deferred cash accumulation for retirement while maintaining a death benefit. People who need permanent life insurance protection but wish to take advantage of possible cash accumulation via an equity index might use IULs as critical person insurance for business owners, premium financing plans, or estate-planning vehicles. IULs are considered advanced life insurance products in that they can be challenging to adequately explain and understand.

Key Takeaways

  • Indexed universal life (IUL) insurance lets the policyholder decide how much cash value to assign to either a fixed account or an equity-indexed account.
  • Index universal life is a form of permanent life insurance.
  • You risk losing money in am index universal life (IUL).
  • IUL insurance policies offer a number of well-known indexes, such as the S&P 500 or the Nasdaq-100.
  • IUL insurance policies offer the possibility of cash accumulation while still providing a death benefit.
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How Does Indexed Universal Life (IUL) Insurance Work?

When you take out an indexed universal life insurance policy, your insurer will help you select the index to use for the cash-value account, part of your policy, and your death benefit. When a premium is paid on the account, a portion pays the cost of insurance based on the insured's life. Any fees are paid, and the rest is added to the cash value.

The total cash value is credited with interest based on increases in an equity index (but it is not directly invested in the stock market). If you own an indexed universal life policy, you can likely borrow against the cash value accused in the policy. However, if you do not pay back your loans, they are deducted from the death benefit.

Some policies allow the policyholder to select multiple indexes. IULs usually offer a guaranteed minimum fixed interest rate and a choice of indexes. Policyholders can decide the percentage allocated to the fixed and indexed accounts. The selected index value is recorded at the beginning of the month and compared with the value at the end of the month. If the index increases during the month, the interest is added to the cash value. The index gains are credited back to the policy either on a monthly or an annual basis.

Example of Universal Life Insurance (IUL)

For example, if the index gained 6% from the beginning of June to the end of June, the 6% is multiplied by the cash value. The resulting interest is added to the cash value. Some policies calculate the index gains as the sum of the changes for the period, while other policies take an average of the daily gains for a month. No interest is credited to the cash account if the index goes down instead of up.

The gains from the index are credited to the policy based on a percentage rate, referred to as the “participation rate.” The rate is set by the insurance company and can be anywhere from 25% to more than 100%. For example, if the gain is 6%, the participation rate is 50%, and the current cash value total is $10,000, $300 is added to the cash value (6% x 50% x $10,000 = $300). IUL policies typically credit the index interest to cash accumulations either once a year or once every five years.

IUL insurance policies reduce risk because no cash is directly invested in the stock market.

Advantages and Disadvantages of Indexed Universal Life (IUL) Insurance

While not for everyone, IUL insurance policies are a viable option for people for permanent life insurance with a cash component that earns interest plus a death benefit. This type of life insurance is more expensive than term life insurance, but you get permanent coverage, and a death benefit paid to your beneficiaries when you die. The policy may even increase in value due to the cash value component, and you may be able to borrow from your account.

Advantages

  • Low price: The policyholder bears the risk, so the premiums are low.
  • Cash value accumulation: Amounts credited to the cash value grow tax-deferred. The cash value can pay the insurance premiums, allowing the policyholder to reduce or stop making out-of-pocket premium payments.
  • Flexibility: The policyholder controls the amount risked in indexed accounts, and the death benefit amounts can be adjusted as needed. Most IUL insurance policies offer a host of optional riders, from death benefit guarantees to no-lapse guarantees.
  • Death benefit: This benefit is permanent, not subject to income or death taxes, and not required to go through probate.
  • Less risk: The policy is not directly invested in the stock market, thus reducing risk.
  • Easier distribution: The cash value in IUL insurance policies can be accessed at any time without penalty, regardless of a person’s age.
  • Unlimited contribution: IUL insurance policies have no limitations on annual contributions.

Disadvantages

  • Caps on accumulation percentages: Insurance companies sometimes set a maximum participation rate that is less than 100%.
  • Better for larger face amounts: Smaller face values don’t offer much advantage over regular UL insurance policies.
  • Based on an equity index: If the index goes down, no interest is credited to the cash value. (Some policies offer a low guaranteed rate over a longer period.) Investment vehicles use market indexes as a benchmark for performance. Their goal is normally to outperform the index. With IUL, the goal is to profit from upward movements in the index.

Is Indexed Universal Life Insurance (IUL) a Good Investment?

An IUL can be a good way to save money in a cash-value account, connected to a market index, it may earn modest returns, but it is first and foremost a life insurance policy, not an investment vehicle.

Can You Lose Money in an Indexed Universal Life Insurance Policy (IUL)?

It is unlikely you will lose money in an IUL because insurance agencies set a guarantee to your principal to protect it against losses in the market. However, there is often a cap on the maximum amount you can earn.

Is Indexed Universal Life Insurance (IUL) Better Than a 401(K)?

For most people, no, IUL is not better than a 401(k) in terms of saving for retirement. Most IULs are best for high-net-worth individuals looking for ways to reduce their taxable income. A 401(k) is a better investment vehicle because it does usually come with the high fees and premiums of an IUL, plus there is not cap on the amount you may earn, unlike an IUL policy.

What Are the Cons of Indexed Universal Life (IUL)?

Indexed universal life policies have a cap set on how much money you can accumulate, often less than 100%, and they are based on an equity index. While you may not lose any money in the account if the index goes down, you won't earn interest. If the market turns bullish, the earnings on your IUL will not be as high as a typical investment account. The high cost of premiums and fees make IULs expensive and considerably less affordable than term life.

Is IUL Better Than Whole Life?

Not necessarily. IUL insurance policies have an investment element, which can grow and earn interest connected to an equity index. Whole life insurance is a more straightforward form of permanent life insurance, with a death benefit and cash value component that acts like a savings vehicle rather than an investment account.

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  1. National Association of Insurance Commissioners. "Life Insurance."