What Is Indexed Universal Life Insurance?
Indexed universal life (IUL) insurance is a type of permanent coverage that provides a death benefit in the event of your passing and a cash value component. Similarly to standard universal, whole, and variable life insurance policies, IUL coverage provides lifelong protection and a cash value component that accrues interest on a tax-deferred basis. However, IUL insurance cash value has direct ties to an underlying stock market index, giving it a higher risk and return potential.
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The Importance of Life Insurance Coverage
Life insurance gives people a sense of security in the face of uncertainty. Research indicates that only 47 percent of households with uninsured primary wage earners would feel financially secure if that primary wage earner suddenly passed away. Alternatively, 68 percent of families with established life insurance believe they could comfortably survive a similar loss.
Whereas term life insurance policies offer coverage during 5-30 year windows before lapsing or renewing at a higher cost, permanent life insurance will deliver your family’s death benefit regardless of how long you live. As with most other permanent plans, an IUL policy lifetime coverage gives policyholders more confidence in the future than they would have with term coverage.
How Does Indexed Universal Life Insurance (IUL) Work?
Whether you live into your hundreds or die younger than expected, permanent life insurance will financially support your family after you pass, given you have kept up with your premiums. Most permanent policies also include a cash value feature that accrues tax-deferred that you can withdraw later for personal use, borrow against, or distribute toward your premiums. Comparatively, a term life insurance policy may lapse when the term expires and does not have cash value growth.
Indexed universal life insurance is a type of permanent coverage that allows you to adjust your death benefit and invest your cash value into an indexed account such as the S&P 500. Though these policies can reap higher rewards, they may impose many additional fees, such as premium, surrender, and administrative expense charges.
Key Features of Indexed Universal Life Insurance
Some of the distinguishing features that separate IUL life insurance from other types of permanent coverage include the following:
- IUL cash value growth directly correlates to its performance of the coordinating index
- Customers can decide how much, up to mail dates limits, IUL cash value to invest.
- Customers can customize their IUL policies through a broad spectrum of policy riders.
- IUL policies allow members to adjust their death benefits as needed.
- IUL policies tend to charge higher premiums and often impose additional fees not seen in other permanent plans.
Cash Value Growth
Most permanent life insurance policies include a cash value component that members can use in many ways, including:
- Withdraw funds
- Borrowing against
- Putting towards their premiums
- Keeping (if they surrender their policy)
Depending on your policy type, your cash value will grow at a fixed, indexed, or blended interest rate. Indexed universal life policies, as the name suggests, grows cash value equivalent to the performance of its underlying stock market index.
Index investing is a technique used to generate funds by channeling money into broad-market equity index accounts. Instead of relying on non-equity earned rates, these accounts grow based on the index of an entire market or market sector. The most popular indexes in the US include:
- The Dow Jones Industrial Average
- Standard and Poor’s 500 (S&P 500)
Investing in an index allows you to diversify stocks between many large corporations, stabilizing the risk and reward element of the stock market. Furthermore, passive indexes commonly outperform their actively managed counterparts and charge lower fees for the service.
Most insurance companies will set a ceiling percentage, also known as its participation rate, on the amount a policyholder can reap from their index gains. Participation rates on IUL life insurance always fall below 100% and occasionally limit earnings as low as 25% on specific policies. These restrictions can ultimately hamstring the true growth potential of your cash value account each year, regardless of how well your underlying index performs.
Floor and Cap Rates
IUL life insurance contracts also include minimum floor and maximum cap restrictions. Typically floor rates can fall between 0-8%, guaranteeing a minimum or neutral return even if your index has a negative year on the market.
Rate caps limit your credited yield regardless of how much your index has gained. For example, if your index earns 20% on a good year, an 80% participation rate would reduce your earnings to 16%, but a secondary cap rate of 10% would further limit gains to a maximum of 10%.
Premium and Death Benefit
As with all other policies, IUL life insurance pays your family a death benefit after you die in exchange for monthly premium payments. However, whereas other policies usually impose a fixed death benefit, IUL policies allow you to adjust within the parameters set by the policy.
Premium rates also vary with IUL insurance, given they can fluctuate based on market activity and recurring policy fees. Furthermore, if it suits your current financial needs, you can supplement your IUL premiums using money from your cash value market returns.
Indexed Universal Life Insurance vs. Other Types of Whole Life Insurance
Cash Value Growth
Risk Tolerance Level
Indexed Universal Life
Traditional Whole Life
Universal Whole Life
Guaranteed minimum return
Variable Whole Life
No guaranteed minimum return
Optional; similar to mutual funds
Higher risk, potential for higher rewards
Each variation of permanent life insurance offers unique risks and rewards. If an IUL policy does not suit your needs, consider an alternative permanent policies such as traditional whole life, universal whole life, or variable whole life insurance.
Traditional whole life insurance
Most popular among permanent life insurance coverage, whole life plans provide families a guaranteed death benefit in exchange for a lifetime of monthly premium payments. Whereas IUL policies allow you to maximize your cash value component in a stock market index, traditional policies set fixed interest gains and restrict outside investment.
Universal life insurance
Universal life and indexed universal life insurance exhibit similar characteristics in how they allow cash value investment. Whereas IUL policies invest in a market index, such as the S&P 500, conventional universal policies grow their cash value based on prevailing interest rates in the general economy.
Variable whole life insurance
While variable whole life coverage resembles universal life insurance in many ways, it invests your cash value into various sub-accounts more in line with the practices of a mutual fund. In exchange for this higher reward potential, variable policies offer no protections or minimum return against investment risks.
How Much Does an Indexed Universal Life Insurance Policy Cost?
Though costs vary widely from person to person, average national premiums for an IUL insurance policy with a $250,000 death benefit purchased by a healthy, non-smoking 30-year-old male would cost around $165 per month. For context, that same policy purchased by a 30-year-old woman might cost $20 cheaper. If purchased by a 50-year-old man, that same policy might cost $465 per month.
Factors That Affect Your IUL Premium
Your ultimate premiums will depend on your coverage amount, age, medical status, location, and much more.
When choosing a plan, you must decide how much coverage you need. Most insurance companies recommend multiplying your annual income by ten or adding up significant future expenses using the DIME method (debt, income, mortgage, education) to calculate an appropriate death benefit. Generally speaking, the higher your death benefit, the more you will pay in premiums.
As you age, insurance companies see you at a higher risk of dying with active coverage. Because of this, the older you are when you register for or renew a life insurance policy, the more you’ll pay in premiums. Since IUL insurance policies never require renewal, signing up for one at a young age will lock you into lower lifetime rates.
Medical Underwriting Results
To qualify for life insurance, your provider may require you to undergo a medical examination and answer some questions about your health and family history. People with healthy lifestyles and a lower likelihood of developing terminal conditions secure the lowest rates.
Your Occupation and Hobbies
Living a high-risk life will negatively affect your insurability. For example, if you regularly enjoy downhill skiing or work on a deep-sea fishing vessel, insurance carriers will view you as a liability and charge higher premiums.
Your Credit History
Your credit score and history help insurers determine your likelihood of making timely premium payments. Poor credit or other infractions on your record, such as bankruptcy claims or repossessed property, could result in costlier coverage.
Policy Endorsements or Riders
Though IUL insurance guarantees a permanent death benefit, you can also fortify your policy by purchasing supplemental coverages known as policy riders. For example, you could opt into an accelerated death benefit rider, allowing you to withdraw funds from your death benefit for hospice care if you fall terminally ill. Also, a waiver of premium rider would allow you to forego premium payments if you become disabled and unable to work. Every rider you add to your policy comes at an additional cost.
Benefits and Drawbacks of Indexed Universal Life Insurance
Deciding between life insurance policies can quickly become overwhelming. Before zeroing in on coverage, consider all the advantages and disadvantages of IUL insurance.
Benefits of IUL Insurance
- Lifetime coverage: IUL life insurance provides permanent coverage, meaning that after you purchase your plan, you guarantee your family their death benefit payout regardless of how long you continue living. Your policy will never expire as long as you stay on top of premium payments.
- Potential for higher returns: Since IUL policies allow members to invest their cash value savings in stock market indexes, they can grow faster than fixed cash value plans depending on their performance.
- Flexibility: Unlike other life insurance policies, IUL insurance plans allow you to adjust your death benefit as needed and supplement your premium payments using your account’s cash value gains.
- Tax advantages: All returns on your cash value investments come tax-deferred. You can move or withdraw these funds tax-free as long as the amount taken does not exceed your cumulative premium payments made.
Drawbacks of IUL Insurance
- Higher premiums: IUL insurance costs more than some other forms of life insurance due to all the ancillary features. Furthermore, these plans tend to charge additional fees not seen in other policies.
- Complexity: IUL insurance policies have many moving parts and unpredictable fees. Their investment options may prove too complex for individuals looking for a more hands-off approach to growing cash value and paying the same consistent monthly bill.
- Riskier than other permanent life options: Unlike fixed-rate cash value policies that steadily gain interest over time, IUL interest gains directly reflect the performance of their underlying index.
- Cap on returns: Even if your index performs superbly in the stock market, your IUL will limit how much interest you can earn on your gains. Rarely will your returns match the actual value of your index.
Who Should Consider Indexed Universal Life Insurance?
While IUL insurance will not make sense for everybody, it could benefit you if you fall into any of the following situations:
- You want to experiment with stock market investment but feel averse to the full financial implications of a market downturn.
- You have exhausted other retirement options and want another outlet to continue contributing to and growing tax-deferred cash value.
- You have a higher budget and can afford the higher premiums and fees affiliated with IUL insurance policies.
- You want a more hands-on and flexible approach to life insurance and retirement planning, as IUL insurance has complex nuances requiring active management.
How to Get Indexed Universal Life Insurance
Follow these steps to streamline the process of finding and purchasing an appropriate IUL insurance policy:
- Assess your financial needs and goals. Consider your family’s long-term needs. Perhaps you intend to fund your children’s college education or have a large balance remaining on your mortgage. Find a plan you can afford now that offers practical benefits.
- Evaluate potential insurance companies offering IUL insurance. Research competing companies and compare their financial strength ratings, customer service reviews, and available policy options. Ensure you select an insurance carrier you can trust.
- Consult with a trusted agent or financial advisor. Seeking expert advice about insurance options and their monetary implications can help narrow your choices.
- Select your preferred policy and apply. Go online and apply or contact an insurance agent once you’ve select adequate coverage. You will likely need to provide sensitive personal information and related documents.
- Undergo medical underwriting and receive your results. To qualify for coverage, you may need to undergo a medical examination and answer some questions about your health to help your provider determine your insurability and appropriate premiums.
- Pay your first premium and receive proof of coverage. Once approved, coverage will begin as soon as you make your first premium payment. Your provider will send you a welcome packet with coverage documents and policy details shortly thereafter.
What This Means For You
IUL insurance offers all the protections of more conventional permanent life insurance policies, flexible death benefits, and a higher potential for cash value investment growth. However, these plans inhibit how much you can realistically gain relative to the performance of your index and can stunt your cash value growth during market downturns. Before enrolling in a policy, talk to a trusted insurance agent or financial advisor to ensure an IUL policy would be worth its higher premiums and fees.