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Indexed Universal Life Insurance

Indexed universal life insurance can help cover many financial needs. But it is just one of many kinds of life insurance available. As you go through your insurance options, you may be unsure of what could be right for your needs and situation.

Indexed universal life insurance is a form of universal life insurance. Another name for this insurance is “IUL insurance.” The “universal” part means that you have flexibility with your premium payments and other policy components. You may adjust your premium, death benefit, and other parts of the policy throughout the contract.

You may elect to change how much you pay in premium costs each year. However, minimum premium amounts must be covered, or the policy will lapse. But as long as the policy stays in force, it will provide you with lifelong coverage.

Another distinction of IUL insurance is that it holds greater potential for earning interest. Interest crediting is tied to an index, like the S&P 500 price index. This may be attractive to those looking for more growth opportunity than just a fixed rate over time.

Let’s get into the basics of indexed universal life insurance, its features, and potential uses for it in a financial plan.

What is Indexed Universal Life Insurance?

Indexed universal life insurance is a type of permanent life insurance. Within an IUL policy are two parts: an insurance component and a cash value component.

As premiums are paid, part of them is put toward the insurance part. This covers the costs associated with having insurance. The insurance part includes the death benefit coverage. The cost of insurance must be covered for the policy to stay effective.

The remaining premiums go into the cash value part. In turn, the cash value grows tax-deferred. Once it has reached a certain point, withdrawals and loans can be made from the policy.

Many indexed universal life policies come with two options for death benefit coverage: a level death benefit or an increasing death benefit. With the level option, your death benefit will stay a fixed amount. However, the cost of insurance will generally be less.

The increasing death benefit option basically includes your face amount plus your cash value amount. That can give greater coverage over time.

Breaking Down Indexed Universal Life Insurance

Generally speaking, an indexed universal life policy allows you to put cash value amounts into a “fixed” component, or toward growth potential linked to a specific index. The cash value grows inside the policy as a result of changes within an index.

You may have a number of indices you can select for your cash value. The S&P 500 price index is most common in many IUL policies. However, there might be other broad index choices, including the Dow Jones Industrial Average or the Nasdaq 100.  

Here’s how the cash value may grow:

  • To be clear, insurers credit interest based on index activity – premium dollars aren’t invested directly into the index.
  • When the index goes up, the cash value may earn interest based on a portion of the index's growth.
  • However, if the index goes down, your cash value doesn't drop in value.
  • An IUL policy comes with a “floor,” or protection against index declines that assures the policy won’t be credited negative interest.
  • Many policies come with a floor of 0%, which means your policy won’t lose value when the index goes down.
  • The flip-side of the protection against losses is capped growth potential.
  • Indexed universal life insurance may come with certain growth limits, including caps and participation rates.

indexed universal life insurance 3 imgSo, say your policy had a "cap" of 10%. If the index shot up 12%, the cash value would be credited just up to the cap of 10%.

Likewise, if your policy had a participation rate of 80% and the index grew 12%, the cash value would grow just by 9.6%. It's also important to note that in the times your policy gets low or no interest, it may decline in value due to policy costs paid.

This interest-earning ability generally gives indexed universal life more growth potential than whole life insurance

How Often is Interest Credited to an Indexed Universal Life Insurance Policy?

Many IUL contracts use an annual crediting method called "Annual Point-to-Point." This method assumes a 365-day year. Once the starting date has passed, the insurance carrier waits a year for the anniversary date. It uses index values on the starting and anniversary dates as the bases for calculating interest.

While many contracts have annual interest crediting, others may credit interest on a more frequent or less frequent basis. For example, some IUL policies might receive interest each month or even every five years.

It can vary based on insurance carrier and specific IUL contract details. You can check any IUL contract, with guidance from a financial professional, for more information.

Potential Benefits of Indexed Universal Life Insurance

Many policyholders get indexed universal life insurance for cash value growth while enjoying death benefit protection. This can help with achieving many goals.

They may include funding key employee insurance, a business succession plan, or college education expenses. Some people supplement their retirement income with IUL policy loans that are tax-advantaged.

Some advantages of indexed universal life insurance may be:

  • You have more flexibility with your policy than other life insurance options might give.
  • Premium amounts may be adjusted, especially as your financial circumstances change.
  • It gives retirement savers another tax-advantaged bucket, outside of qualified plans, to build wealth tax-deferred.
  • The cash value grows tax-deferred over time unless the policy is ceased before reaching maturity.
  • With possibility of index-linked growth, you may enjoy higher interest-crediting potential than with other life insurance options.
  • The value of your policy is protected from negative index changes.
  • You can access your cash value for many reasons and goals.
  • Cash value amounts can be used to pay for retirement, via loans, while being income tax-free.
  • Higher interest-crediting potential may benefit those looking to maximize their estate or legacy wealth value for loved ones.
  • The policyholder controls the amounts of cash put into the fixed component and the index-linked growth component.

 

Potential Cons of Indexed Universal Life Insurance

Having said that, indexed universal life insurance may also come with disadvantages, including:

  • Indexed universal life policies can be more complex than other life policies.
  • Premiums for an IUL policy will be higher than for whole life and term life policies. 
  • If costs of insurance aren't covered, the policy will end.
  • Caps and participation rates can limit the growth potential of cash value amounts.
  • Cash value growth doesn't include dividends.
  • In periods where low or no interest is credited, policy costs can mean net losses for that period.
  • A policy lapse could leave trigger a substantial tax obligation.
  • Costs of insurance are likely to go up with aging. 
  • Outstanding policy loans come with interest, and if the policyholder dies, the outstanding loans are taken from the death benefit.
  • Smaller face values in an IUL policy don't necessarily offer more benefit than in a traditional UL policy.


Is Indexed Universal Life Insurance Right for You?

indexed universal life insurance img 2Generally speaking, indexed universal life insurance is a long-term commitment. An IUL policy may be a better solution for people with the income and financial resources to cover ongoing premium payments.

As you consider this option, think over your needs, resources, goals, and situation. Why are you considering indexed universal life insurance? What goals do you have for it? Some reasons why people buy indexed universal life insurance are for:

  • Maintaining financial security of dependents
  • Lowering tax obligation on their estate for their beneficiaries
  • Building a cash value to pay for retirement
  • Growing cash value amounts to pay for a new vehicle or other nice-to-haves 
  • Helping children or grandchildren with college tuition or costly educational expenses
  • Being able to pay off the mortgage or other debt loads
  • Using the cash value for income in down-market periods
  • Enjoying another tax-advantaged bucket besides qualified retirement plans

Those looking at permanent insurance for estate planning goals may also want to consider IUL insurance. Since an IUL policy doesn't have as many guarantees built into it as a whole life policy has, you can get more death benefit protection.

Other Factors to Consider

No matter what type of insurance you may get, it should help you fulfill your goals. This discovery process starts with asking and answering questions. Are you considering life insurance for income or financial protection? Do you plan to use it for more than just death benefit coverage? If so, what other goals might you have for it?

If you just need life insurance for financial protection, you may want to consider term life insurance. The "pure" death benefit protection could be a better fit for what you need. Term coverage is available for timespans ranging from 10-30 years.

However, if you are concerned about high-cost items like healthcare in retirement, permanent options like IUL insurance should be considered. Many indexed universal life policies come with insurance riders including "living benefits." With these benefits, you can accelerate your death benefit to pay for terminal illnesses, home healthcare, long-term care, and other needs. 

Summing It Up

As you shop around, working with a financial professional can bring efficiency and clarity to your research. If you are ready for personal guidance, financial professionals stand ready to help you at SafeMoney.com.

Use our "Find a Financial Professional" section to connect with someone directly. Should you need a personal referral, call us at 877.476.9723.

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