What Is Indexed Universal Life Insurance (IUL)?

What Is Indexed Universal Life Insurance (IUL)?

Indexed universal life insurance is a form of permanent life insurance that combines a cash value component with a death payment. The money in a policyholder's cash value account can generate income by monitoring a stock market index chosen by the insurer, such as the Nasdaq-100 or the Standard & Poors 500.

 You may also have a fixed-rate account where you may specify how much money goes into each account.

Although the interest rate calculated from the stock index account may vary, the policy includes an interest rate guarantee that restricts your losses.

 It may also limit your potential benefits. These policies are more volatile than traditional universal life policies.

Key Takeaways

Indexed universal life insurance allows the policyholder to specify how much cash value to allocate to a fixed-rate and equity-indexed accounts.

Indexed universal life is a type of permanent life insurance that, like universal life, provides for variable premiums and, potentially, a variable death payout.

IUL insurance contracts can earn interest credits by tracking a variety of well-known equities indexes, such as the S&P 500 or the Nasdaq-100.

IUL plans normally cap your returns while ensuring a minimum interest rate.

How does Indexed Universal Life Insurance Work?

IUL plans, like universal life insurance, have flexible rates. You can pay less or skip premiums, and you may be able to change your death benefit as well. What distinguishes IUL is how the cash value is invested.

When you purchase an indexed universal life insurance policy, the insurance company will assist you in determining which index to use for all or part of your policy's cash value account and death benefit. When a premium is paid on the account, a part goes toward the cost of insurance dependent on the insured's life. Any fees are paid, and the balance is added to the cash value.

The total cash value earns income based on growth in an equity index (but is not directly invested in the stock market). If you possess an indexed universal life policy, you can most likely borrow against its cash value. However, if you do not repay your debts, they are subtracted from the death benefit.

Key Features:

Indexed Universal Life insurance offers the following primary characteristics, among others:

·       When premiums are paid on time, they provide permanent, lifetime coverage.

·       Premiums can be adjustable, and the death benefit may also be.

·       Cash value and prospective growth through an equity index account.

·       A fixed interest option can be partially funded with cash value.

·       The minimum interest rate is guaranteed, although growth are normally limited at 8% to 12%.

·       Cash value built up can be utilized to reduce or even pay premiums without deducting from your death benefits.

·       Some insurance may allow the policyholder to choose several indices.

Policyholders can specify the percentages allocated to fixed and indexed accounts. The specified index value is taken at the start of the month and compared to the value at the conclusion of the month. If the index rises throughout the month, the interest is credited to the cash value. The index gains are refunded back to the insurer, either monthly or annually.

People who want permanent life insurance coverage yet want to take advantage of potential capital accumulation through an equity index may utilize Indexed Universal Life as key person insurance for business owners, premium-financing programs, or estate-planning vehicles.

Example of Indexed Universal Life Insurance.

Assume the specified index for your Indexed Universal Life insurance increased by 6% between the beginning and end of June. 6% is multiplied by the cash value. The accumulated interest is added to the cash value. Some policies assess index gains as the sum of changes during the time, while others use an average of daily increases over a month. When the index falls rather than rises, no interest is credited to the cash account.

The profits from the index are attributed to the insurance using a percentage rate known as the "participation rate."

The pros and cons of Indexed Universal Life insurance

While not for everyone, Indexed Universal Life insurance policies are a realistic choice for those looking for permanent life insurance with an interest-bearing cash component and a death payment. This form of life insurance is more expensive than term life insurance, but it provides permanent coverage and allows your dependents to receive the death benefit tax-free when you die.

 The cash value component of the insurance may potentially enhance its worth, allowing you to borrow from your account.

Benefits

Flexible premiums:

Just like with normal universal life insurance, policyholders can raise or cut their premiums in times of hardship.

Cash value accumulation:

Amounts credited to the cash value accrue tax-free. The cash value can cover insurance premiums, allowing the policyholder to minimize or eliminate out-of-pocket premium payments.

Investment flexibility:

The policyholder has control over the amount risked in equity-indexed accounts, and death benefit amounts can be changed as needed. Most Indexed Universal Life insurance contracts have a variety of extra riders, ranging from death benefit guarantees to no-lapse assurances.

Death benefit:

This is a permanent benefit that is not subject to income or death taxes and does not need probate.

The drawbacks

Caps for accumulation percentages:

Insurance firms may set a maximum participation rate that is less than 100%.

Better for greater face quantities. Smaller policy face values do not provide significant advantages over standard UL insurance policies.

Based on the variable equity index:

If the index drops, no interest is credited to the cash value. (Some insurance provide a low guaranteed rate for a longer term.) Other investment vehicles utilize market indexes to assess their performance. Their objective is usually to outperform the index. The purpose of IUL is to profit from the index's rising fluctuations.

Growth excludes stock dividends:

Because the insurance provider only purchases options in an index, you are not directly involved in equities.

Is Indexed Universal Life Insurance (IUL) a good investment?

An IUL can be an excellent method to store money in a cash value account linked to a market index and generate moderate returns, but it is primarily a life insurance policy, not an investment instrument.

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

You are unlikely to lose money in an IUL since insurance companies guarantee your investment against market losses. However, there is typically a limit to the amount you may make.

Is Indexed Universal Life Insurance (IUL) better than a 401(k)?

In terms of retirement savings, IULs are not superior to 401(k)s for the majority of individuals. Most IULs are ideal for high-net-worth people seeking to lower their taxable income. A 401(k) is a superior investment vehicle since it does not have the hefty fees and premiums of an IUL, and there is no limit to the amount you may earn, unlike an IUL policy.

What are the disadvantages of Indexed Universal Life Insurance (IUL)?

Indexed universal life insurance limit the amount of money you may amass, frequently by less than 100%, and are dependent on a potentially volatile market index.

Is Indexed Universal Life better than Whole Life?

Not necessarily. Indexed Universal Life insurance products have an investment element that can grow and generate income based on an equity index. They also provide flexible premiums.

Whole life insurance is a simpler version of permanent life insurance, with a guaranteed death benefit, constant premiums, and a cash value component that functions as a savings vehicle rather than an investment account. Whole life is easier to grasp, although it may not deliver the same benefits as Indexed Universal Life.

The Bottom Line

Indexed universal life insurance is a type of permanent life insurance that combines a cash value component with a death payment. The money in the cash value account can generate interest by tracking an equity index chosen by the insurer, and it can also typically be partially transferred to a fixed-rate account. However, indexed universal life insurance limit the amount of money you may acquire, generally to less than 100%, and are dependent on a potentially volatile market index.

Beyond the death benefit provided by an Indexed Universal Life policy, these should not be regarded the best retirement savings vehicles. A 401(k) is a preferable alternative for that purpose because it does not have the hefty fees and premiums of an IUL policy.