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Indexed Universal Life Insurance

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Indexed universal life (IUL) insurance is 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. While IUL may seem complex, doing your research can help you understand this type of life insurance policy to decide whether it’s right for you.

Many policyholders appreciate IUL policies due to the flexibility, since premiums and death benefits can be adjusted. In addition, IUL policies come with an investment portion that may be attractive to some policyholders. Is indexed universal life right for you? Doing research on this type of policy may help you decide.

Indexed universal life insurance defined

Indexed universal life 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 puts a portion of that money in 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. IUL policies typically guarantee a certain interest rate for returns, but also cap your returns at a certain amount.

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 The amount of money you can make in returns is capped
Flexible premiums Returns are based on an equity index like the Nasdaq Composite, which may be less lucrative than other money market investments
Interest rate protection
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 entire life, 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.

Interest rate protection

IUL insurance policies ensure that your investment won’t dip below a certain interest rate, but everyone’s tolerance for risk is different and you should consult with a financial advisor to see if this may be a fit for your financial goals Choosing to reduce your premiums, or to stop paying them, can reduce your policy’s cash value and death benefit.

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

The amount of returns you can earn on your cash value account is capped at a certain amount, which may be a downside for those hoping for an investment with greater potential risks and rewards.

Based on equity index

IUL insurance only earns money based on market indices like the NYSE Composite or Dow Jones Industrial Average. These indices represent a bucket of stocks and bonds. 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 may be a good fit for people who want coverage that includes a savings vehicle. It may also be a good choice for people who can afford permanent life insurance coverage and need flexible death benefits 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. Chances are, one of the following types of life insurance may be able to meet your needs and budget.

Term life insurance

Term life insurance covers the insured for a specified period, typically 10 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 usually 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 life insurance companies depend on your individual preferences. If you care most about customer satisfaction, you may want to choose a company that ranked highly in the J.D. Power 2021 U.S. Individual Life Insurance Study. If you care about a company’s ability to pay out claims, you may want to pay special attention to AM Best scores. An independent insurance agent may be able to assist you with the process.

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.

What is the difference between term and permanent life insurance?

Term life insurance only stays in effect for a predetermined number of years, which is typically between 10 and 30. It may be useful to policyholders who only want coverage for a certain period of time, such as during the length of their mortgage or while their children are young. Permanent life insurance remains active until the policyholder passes away, and typically includes a cash value portion that acts as a savings or investment account. However, permanent life premiums are typically much higher than term life premiums.

Should I consider purchasing life insurance for my child?

It’s unsettling to think about a child’s death. Thanks to modern medicine, child death rates in the United States are very low. However, some families prefer to purchase life insurance for their children for a few reasons. The median cost of a funeral in the United States is $7,640, so life insurance for children provides the peace of mind that these costs would be covered in the event that the unthinkable were to happen. Also, life insurance can make your child more insurable in the future. Life insurance rates are lowest when you’re young. By locking in low rates when your child is young, they may be able to keep those low rates, even if they were to develop health issues in the future.

Written by
Michael Evans
Former Personal Finance Contributor
Michael Evans is a former contributor to Bankrate and 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. 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.
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