Indexed universal life insurance is a hybrid life insurance policy that lasts a lifetime and makes the most of stock market wins. But it’s complex, and your earnings are limited.
Indexed universal life insurance (IUL) is a type of permanent policy that’s tied to an equity index, such as the S&P 500. Like all permanent policies, it lasts a lifetime and part of your premium is invested to give your policy a cash value. Rather than offering a fixed rate of return, your cash value pays a return based on the performance of that index.
Your insurer will set a minimum interest rate, though, so you won’t lose money. But if the market dips, your returns might be lower.
Once you’ve built up enough cash value, you can take out loans against your own policy, or use the cash to cover your premiums. If you decide to cash in your policy, you’ll get the cash value — but your beneficiaries won’t receive a death benefit when you die.
An index measures the performance of a group of investments, like stocks and bonds. For example, the S&P is a stock market index that monitors 500 of the largest companies listed on the US stock exchange. It’s a good reflection of the state of the market. With IUL, your insurer doesn’t invest your money in the market. They use the index’s interest rate to come up with a rate for your policy.
IUL is essentially two products in one: a life insurance policy and an investment.
When you pay your premium, a portion pays for an annual renewable term life insurance policy, plus any admin fees. The rest goes towards the cash value portion of your policy, which earns interest based on the increases in an equity index — like the S&P 500 or NASDAQ-100. Some providers will allow you to choose multiple indexes, and allocate a certain percentage to each.
Insurers assess index performance each month. If the index performs well, those “gains” will be credited back to your policy on a monthly or annual basis. Let’s say the index jumped up by 5% from January 1 to January 31. Your insurer will multiply 5% by your cash value, and add the resulting interest to your cash value.
This is where it gets complicated: The gains are based on a “cap rate” or maximum interest rate, and a “participation rate” or a percentage rate set by your insurer. So, if the gain is 5% and below the cap rate, the participation rate is 50%, and the cash value of your policy is $15,000, the insurer will add $375 to the cash value.
On the other hand, if the index dips, your insurer won’t credit any interest to your cash value.
These are the other features of IULs:
For the average person, an IUL is unnecessarily complex. If you’re planning for retirement, you might be better off funnelling your savings into a 401(k) or IRA. While those accounts are subject to contribution limits and don’t have the same principal guarantees, you’ll see more money when the market is performing well.
However, if you’re a high-income earner, the tax benefits of an IUL may be worth the cost of the policy. The same goes for long-term investors who are okay with potentially low returns in less-than-stellar years.
If indexed universal life insurance isn’t quite right for you, look into these permanent policies:
IULs are best for wealthy individuals who want to take advantage of stock market returns while building up a tax-free retirement. While there is a potential for big gains, these policies are expensive and complex, and insurers cap your returns.
Before committing to any kind of coverage, be sure to compare life insurance providers.
What’s the difference between universal life and indexed universal life insurance?
While these policies are very similar, the cash value portion is treated differently. With standard universal life, you’ll earn a fixed rate. Your earnings from an IUL are dictated by an equity index, and by your insurer’s participation rate.
When do I need to take a medical exam?
To apply for coverage, you’ll typically need to take a medical exam or answer a health questionnaire. However, there are a handful of providers that offer IULs without medical underwriting.
I don’t fully understand the IUL policy offered by my provider. What should I do?
IULs are complicated financial products. Your insurance company should be able to connect you to an in-house financial advisor to explain the ins and outs of the policy and answer any questions you may have.
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