Indexed Universal Life Insurance

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If you are a first-time life insurance shopper, the variety of policies on the market may overwhelm you. Some life insurance policies only provide a death benefit, while others also offer investment options. If you are looking for a life insurance policy that can earn money, with only moderate risk, while offering flexible benefits and premium features, an indexed universal life insurance policy might be the one for you.

Indexed universal life insurance defined

Indexed universal life (IUL) insurance is a type of permanent life insurance. A permanent life insurance policy features two components: a death benefit and a savings account. Each time you make a premium payment, the insurer invests a portion of that money to build your policy’s cash value account. Traditional universal life insurance policies earn gains based on a money market rate of interest. But the savings component of IUL insurance is linked to an index of investments, like the Nasdaq Composite or S&P 500.

Typically, permanent life insurance policies provide a lifetime of protection if you continue to pay the premiums. After your policy builds a cash value, you can borrow against it. However, you must repay loans, with interest, or risk reducing your policy’s death benefit. IUL policies provide flexible coverage, enabling you to alter your premiums and adjust your policy’s death benefit, but only after the savings vehicle accumulates enough money to cover the policy’s costs.

How an indexed universal life insurance policy works

The insurance market offers various IUL products. Some offer lifetime protection, while others provide guaranteed protection up to a certain age, typically to age 85 or 90. Some IULs provide coverage up to the maturity date, typically when the insured turns age 95 or 100, if the policy maintains a cash value, then pays the insured the cash value and suspends coverage.

With a IUL insurance policy, the provider will make all investment decisions. The carrier may invest in bonds or up to four or five market indices, which may include the Fidelity AIM Dividend Indexed account, Nasdaq Composite account or one or more S&P 500 accounts. Since markets fluctuate, IUL insurance policies typically feature an interest rate guarantee, which provides downside protection for your cash value account.

IUL insurance policies earn tax-deferred gains and after your policy builds a cash value, you can take out a loan against your earnings. Since you are borrowing your own money, you can use the funds for whatever you like, to make a down payment on a house, pay your child’s college tuition or even take a dream vacation. However, the insurer will require you to repay the loan with interest – and you may face tax liability.

Typically, IUL policies allow you to alter the death benefit. However, if you want to increase the face value, the carrier may require you to take a medical examination. Once your policy has accumulated a cash value, you may also have the option to adjust your premium. But if you reduce your premiums to be too low, or stop paying them altogether, you could exhaust your accumulated cash value and cause your policy to lapse.

Pros and cons of IUL policies

Pros Cons
Cash value account More expensive than other types of life insurance
Flexible death benefit Equity caps
Flexible premiums Based on equity index
Only moderate risk
Unlimited contributions

Pros

Cash value account

The cash value account invests a portion of each premium payment. Since permanent life insurance is designed to cover you through your golden years, your investment can grow to a significant nest egg, giving you funds to access when life’s emergencies strike.

Flexible death benefit

Having the ability to increase or decrease your policy’s death benefit gives you more flexibility in the future. Oftentimes, young parents need more coverage than they will need when they reach retirement age.

Flexible premiums

IUL policies enable you to change your premium after accumulating a cash value. Altering the amount you pay can come in handy during difficult economic times.

Moderate risk

IUL insurance policies feature downside protection and don’t allow you to make investment choices. Choosing to reduce your premiums, or to stop paying them, can reduce your policy’s cash value and death benefit. But overall, IUL insurance only poses a moderate risk to your investment.

Unlimited contributions

Contributions to IULs are only limited by the premiums you can afford to pay and federal tax limits. Since IULs allow you to adjust your premiums, you can choose to pay more to grow your cash value account.

Cons

More expensive than other types of life insurance

Like all permanent life insurance policies, IULs are expensive because they provide a death benefit and a savings vehicle. This requires insurers to set rates based on the cost of providing insurance as well as investment needs.

Equity caps

Based on market fluctuations, insurance carriers can cap IUL earnings. Insurers can adjust cap rates for each index and adjust rates monthly based on market performance.

Based on equity index

IUL insurance only earns money based on market indices. Other forms of permanent life insurance offer more investment options, with the potential to grow your policy’s cash value faster.

Who is an indexed universal life policy good for?

An IUL insurance policy is a good fit for people who want coverage that includes a savings vehicle without a lot of investment risk. It is also a good choice for people who can afford permanent life insurance coverage and need flexible death benefit and premium options to meet future needs.

Alternatives to indexed universal life insurance

IUL insurance is not for everyone. The insurance market offers a variety of life insurance policies, which gives options to fit most investment needs and budgets.

Term life insurance

Term life insurance covers the insured for a specified period, typically 1 to 30 years. While term life policies feature a death benefit, they do not build a cash value. Many term life policies are renewable, which enables policyholders to extend their coverage for another term, usually at a higher rate due to their increased age. Most term life policies do not return any of the premiums when the coverage ends and only offer coverage up to a certain age, usually around 80. Typically, term life insurance is the cheapest coverage, especially for people who purchase a policy when they are young and healthy.

Whole life insurance

This type of permanent life insurance features fixed premiums and a level death benefit, which the policyholder cannot change. Like IUL coverage, whole life policies build a cash value, which you can borrow against. Whole life policies, unlike term policies, do not cut off coverage at a certain age, so you can remain protected even if you live past 100.

Variable life insurance

Variable life insurance, a type of permanent life coverage, features a death benefit and savings account. Variable life policies put the insured in the investment driver’s seat, allowing them to choose the type of investments they prefer, which may include bonds, money market mutual funds and stocks. While variable life policies offer more flexible investing than IULs, they can pose more risk. If investments do not perform well, the policy’s cash value and death benefit can decrease.

Universal life insurance

Universal life insurance works the same way as IULs, except it builds a cash value based on a money market rate of interest instead of a market index. This type of permanent life insurance also allows policyholders to adjust their death benefits and premiums.

Variable universal life insurance

Variable universal life insurance, a form of permanent life coverage, combines the features of variable and universal life policies. This type of policy enables you to invest your savings as you choose and allows you to alter your premiums.

Frequently asked questions

What is the best life insurance company?

Life insurance does not come in one-size-fits-all packages. Some people need the affordable temporary coverage that term life insurance offers, while others want coverage that offers protection and investment options. The best insurance companies offer a good combination of financial strength, coverage and price.

What impacts my life insurance rates?

Numerous factors can affect your life insurance rates, including your age, family and personal health history, gender, hobbies, tobacco use and the type of policy and amount of coverage you buy.

Written by
Michael Evans
Personal Finance Contributor
Michael Evans has worked in numerous industries, including education, finance, government, insurance and journalism. He began writing professionally while working for the world's first online mortgage brokerage in San Francisco, California. His writings have appeared in print and online publications, including Fox Business, International Living, Motley Fool and Yahoo Finance. Michael has contributed to Bankrate since 2013. He and his family divide their time between residences in Northern California and Colombia. When Michael is not writing, he enjoys working in his photography business and playing with his cat, Cyndi Lou.