Indexed Universal Life Insurance
Indexed universal life insurance has two main components: A death benefit and a growing cash value. Instead of tying the policy’s cash value growth to a fixed interest rate, indexed universal life growth is linked to the performance of a market index, such as the S&P 500.
What Is Indexed Universal Life (IUL) Insurance?
Like other types of permanent life insurance, indexed universal policies offer lifelong coverage so long as premiums are paid.
They also offer the possibility of cash accumulation.
Cash value growth is linked to the performance of a selected market index, such as the S&P 500 or the Dow Jones Industrial Average.
Like other universal life insurance policies, the death benefit is determined at the beginning of the policy — but it may be adjusted later if needed.
Likewise, indexed universal life insurance offers flexible premium options. You can skip or stop premium payments under certain circumstances — but there must be enough money in your policy’s cash value to cover expenses.
How Do Indexed Universal Life Policies Work?
When you purchase an indexed universal life insurance policy, part of your premium goes to the death benefit — the money your heirs receive after you die — and insurer fees.
The rest is invested into a stock market index or a combination of indexes. You may also have the option of a fixed-interest investment.
An index is a broad collection of various stocks. For example, the S&P 500 tracks the performance of the 500 largest publicly traded companies.
However, the money in your policy’s cash value isn’t directly invested into an index.
Instead, the insurance company uses the index performance as a measuring device to determine how much interest to credit to your policy’s cash value.
How much your cash value earns is subject to floors and caps set by the insurance company. The floor is the lowest your account rate can go. It is often set at zero or 1 percent.
For example, if the selected index drops to negative 3.5 percent next year, you’re protected. Your account will not lose its original cash value.
You won’t earn any money in this scenario — but you won’t lose any, either.
A cap is the highest interest rate your account can earn. According to Forbes, caps are often in the range of 8 percent to 18 percent.
For example, the S&P 500 may rise by 15 percent. But if your policy cap is set at 12 percent, you will only get credited with 12 percent.
Make sure to review the floors and caps of potential plans. They can have a major impact on your policy’s long-term performance.
Benefits of Indexed Universal Life
Indexed universal life insurance offers many advantages, including flexibility and investment opportunity.
- Control and Flexibility
- Indexed universal life policies give you the option to adjust the death benefit and premiums over time.
- Cash Value Growth
- Indexed universal life policies offer the potential for higher cash value growth than some other insurance options, such as traditional universal life. Over time, you can withdraw funds from your cash value, or borrow against it.
- Unlimited Contributions
- Unlike other retirement savings vehicles, such as IRAs, indexed universal life insurance policies have no limits on annual contributions.
- Death Benefit
- You may be able to increase or decrease the death benefit over time. Keep in mind that increasing the policy death benefit will likely require you to pass a new medical examination.
Disadvantages of Indexed Universal Life
Indexed universal life insurance is designed with flexibility in mind — but so many moving parts can make policies complex and confusing.
Make sure you understand all aspects of these policies before buying one.
- Caps on Earnings
- These policies often include caps, which limit the growth of your policy’s cash value. Caps also tend to decline over time, reducing the earning potential of your account.
- Stock Market Risk
- Because indexed universal life insurance is tied to the performance of an index, it exposes you to stock market risk and volatility. Returns are not guaranteed.
- Cost and Fees
- While indexed universal life trends cheaper than some other types of life insurance — such as whole life insurance — it is more expensive than term life coverage. Indexed universal policies also include several fees that may increase over time.
Should You Get Indexed Universal Life Insurance?
Indexed universal life insurance isn’t right for everyone.
Premiums tend to be more expensive for universal life insurance compared to term life insurance.
For example, a 40-year-old healthy man purchasing a 30-year term life insurance policy worth $250,000 may pay $340 a year in premiums.
The same man purchasing the same amount of coverage through an indexed universal life policy could pay $3,100 a year in premiums.
Like all life insurance, it’s more expensive to purchase a policy when you’re older.
The cost of insurance can quickly eat into the policy’s cash value growth if most of your premiums go to cover the death benefit and associated fees.
But if lifelong coverage is important to you, indexed universal life may suit your needs.
For healthy high-income earners, these policies may be a good way to provide coverage for your family while also diversifying your portfolio.
4 Cited Research Articles
- Chorpenning, A. (2020, July 17). Understanding Universal Life Insurance. Retrieved from https://www.forbes.com/advisor/life-insurance/universal-life-insurance/
- Gurley, D. (2018, January 29). The Golden Rules Of Buying Indexed Universal Life Insurance. Retrieved from https://www.forbes.com/sites/forbesfinancecouncil/2018/01/29/the-golden-rules-of-buying-indexed-universal-life-insurance/#2a66531280b9
- American Institute of CPAs. (n.d.). Life Insurance: Understand Your Choices. Retrieved from https://www.360financialliteracy.org/Topics/Spending-Saving/Insurance/Life-Insurance-Understand-Your-Choices
- DaveRamsey.com. (n.d.). What is universal life insurance? Retrieved from https://www.daveramsey.com/blog/universal-life-insurance