What Is Indexed Universal Life Insurance?

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Updated: 19 March 2024
Written by
Bob Phillips
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Indexed Universal Life Insurance, or IUL, is a type of life insurance policy that many people come across when they’re looking for ways to ensure the financial security of their loved ones. If that describes you, then you’re in the right spot to understand the costs associated with IUL and how it functions.

This type of life insurance provides both a death benefit and a cash value component that’s tied to a stock market index, giving it unique features that differentiate it from other life insurance products.

As you investigate the world of life insurance, understanding the costs and benefits associated with different policies is essential. Many people find themselves overwhelmed by the number of options available, but rest assured, by the end of this article, you’ll have a clear grasp of IUL insurance and its associated expenses.

It’s also worth noting that while life insurance is a personal decision, not taking timely action can have long-term financial repercussions for your family. Delaying or avoiding this crucial step might leave your loved ones in a challenging financial situation should the unexpected occur. It’s always better to be informed and prepared than to regret missed opportunities.

 

Key Takeaways

  • IUL involves some investment risk.

  • Unlike term life insurance, IUL policies build cash value.

  • You can borrow against your IUL policy as the cash value builds.

What is Indexed Universal Life Insurance?

Indexed Universal Life Insurance (IUL) is a type of permanent life insurance that offers both a death benefit and a cash value component. The cash value’s growth is linked to a stock market index, allowing for potential positive returns while also providing protection against market downturns.

IUL insurance is a versatile financial product designed to offer lifelong coverage. Unlike traditional whole life policies, it offers more flexibility in premium payments and the potential for cash value growth. The unique aspect of IUL is its cash value account component, which is tied to a specific stock market index, like the S&P 500. This means when the index performs well, the cash value has the opportunity to grow, but with caps on potential returns.

Additionally, most IUL policies come with a floor, ensuring that even if the market declines, you won’t lose your principal investment. This combination of potential growth with protection against market downturns makes an IUL account an attractive option if you’re looking for both life insurance coverage and a financial tool for wealth accumulation.

Important: IUL policies provide a death benefit for your family and build cash value you can use during your lifetime.

One of the standout features of an Indexed Universal Life Insurance policy is its adaptability. You have the ability to adjust your premium amounts and death benefits, catering to your changing financial needs. For instance, during healthy markets, you might choose to pay a higher premium to boost the cash value, while in tighter times, you might opt for a lower premium.

The cash value component of an IUL is tax-deferred, meaning you won’t pay taxes on its growth until you withdraw funds. This can be advantageous if you’re looking for tax-efficient ways to grow your savings. Moreover, the ability to take out loans against this cash value offers an added layer of financial flexibility. If you need immediate funds, you can borrow from your policy’s cash value account, often at competitive interest rates.

However, it’s important to approach IUL with a comprehensive understanding. While the floor protects against negative market returns, it’s also paired with a cap on positive returns. This cap limits the growth potential of the cash value, which means that in booming market years, you won’t experience the full surge of the index.

How does Indexed Universal Life Insurance Work?

One of the unique benefits of an Indexed Universal life policy is the way the cash value grows. When the associated index (usually the S&P 500) sees positive performance, the cash value of the policy has the chance to grow, but there’s typically a cap on the maximum return. For instance, if the index grows by 12% and the cap is set at 8%, the cash value will only increase by that 8%.

On the flip side, most IUL accounts have a protective floor, ensuring that even if the market performs poorly, your cash value won’t drop below a certain percentage, often set at 0%. This means the cash value won’t lose value even in a declining market.

Important: You can’t lose your cash value if the market drops, but your gains are capped by the insurer.

Another notable feature of an IUL insurance policy is its flexibility. You can often adjust your premium payment and death benefit based on your evolving financial circumstances. This adaptability, combined with the potential for tax-deferred growth and the option to take loans against the cash value, makes IUL a financial product that can cater to various needs, from legacy planning to retirement savings.

In addition to these features, the loan provision of an IUL is particularly noteworthy. As the cash value accumulates over time, you have the option to borrow against it without undergoing the stringent checks and approvals associated with traditional loans. This provides a readily accessible source of funds for emergencies or opportunities.

However, if a loan isn’t repaid, the death benefit can be reduced by the outstanding amount, potentially impacting the financial security intended for your beneficiaries.

What is the Average Cost of IUL?

The cost of an Indexed Universal Life Insurance (IUL) policy varies based on several factors, including age, gender, health status, and the amount of coverage desired, like the cost of any life insurance policy.

Premiums for IUL policies are generally higher than those for term life insurance because of the cash value account component and the potential for growth tied to a stock market index. Additionally, IUL insurance policies come with associated fees and charges.

These can include:

  1. Premium Load: A percentage taken out of each premium payment, which covers administrative costs.
  2. Cost of Insurance (COI): The actual cost of the life insurance based on the age, gender, and health of the insured.
  3.  Policy Fees: Flat fees charged annually.
  4. Surrender Charges: Fees incurred if the policy is canceled before a certain period.
  5. Fund Management Fees: If the policy offers multiple indexed accounts or has a general account, there might be fees associated with managing these funds.

It’s important to note that while the cash value component offers growth potential, the various fees can eat into the returns, so it’s crucial to understand all associated costs before purchasing an IUL policy.

These are the average monthly costs for $250,000 Indexed Universal Life (IUL) insurance coverage, assuming you’re a healthy non-smoker:

Age (yrs) Male ($ per month) Female ($ per month)
25 – 35 $96 – $122 $71 – $96
35 – 45 $122 – $171 $96 – $148
45 – 55 $171 – $303 $148 – $238
55 – 65 $303 – $491 $238 – $445

As you can see, these figures illustrate the importance of securing your policy early in life when premiums are generally lower.

How to Choose the Right Coverage Amount

Selecting the right coverage amount for an Indexed Universal Life Insurance (IUL) policy requires careful consideration of both your insurance needs and your investment goals. Here’s a step-by-step approach:

  1. Assess Immediate Financial Obligations: Begin by calculating immediate financial obligations that your loved ones would face upon your passing. This includes outstanding debts, mortgages, and any immediate expenses, such as funeral costs.
  2. Estimate Future Financial Needs: Consider future expenses like college tuition for children, spouse’s retirement needs, or any other significant anticipated costs.
  3. Evaluate Existing Savings and Investments: Subtract your existing savings, investments, and any other life insurance policies you already have. This will give you an idea of any financial gaps that the IUL policy should cover.
  4. Factor in Investment Goals: Since IUL has a cash value component that can grow over time, think about how much you’d like to contribute and potentially grow as a supplementary retirement fund or other financial goal.
  5. Understand IUL Components: To make an informed decision, it’s vital to grasp the IUL’s components like the participation rate, cap, and its relationship to a chosen index.

Here’s an example using the Dow Jones, participation rate, and cap.

Let’s say you’re considering an IUL account linked to the Dow Jones Industrial Average (DJIA). The insurer offers a 100% participation rate and has set a cap of 10% on returns.

  • Participation Rate: This is the percentage of the index’s gain that your cash value will benefit from. A 100% participation rate means you’ll get the full benefit of the index’s growth, but only up to the cap.
  • Cap: The cap is the maximum rate of return your policy can earn in a given period. So, even if the DJIA grows by 15% in a year, with a 10% cap, your cash value will only grow by 10%.

Suppose the DJIA experiences a 15% growth in one year. With the 100% participation rate, your potential return is 15%. However, due to the 10% cap, your cash value will only increase by 10%.

In contrast, if the DJIA grows by 5%, with a 100% participation rate and no cap limitations in play, your cash value will increase by the full 5%.

Understanding these components helps in setting realistic expectations for the policy’s cash value growth.

Important: Take the time to make sure you understand how IUL works before applying.

Benefits Of Indexed Universal Life Insurance

Flexible Premiums

IUL policies offer flexible premium payments. This means you can adjust how much you pay, within certain limits, depending on your financial situation. It provides a level of adaptability that’s not often found in other life insurance products.

Cash Value Accumulation

The cash value component of an IUL can grow based on the performance of a chosen index, offering potential for tax-deferred growth. This can serve as a supplementary savings or retirement fund.

Downside Protection

One of the standout features of IUL is the floor on the interest rate. Even if the stock market performs poorly, your policy won’t lose value, ensuring a certain level of protection for your investment.

Loan Options

You can borrow against the cash value of your IUL policy. This offers a potential source of funds for emergencies or opportunities without the need to liquidate other assets.

Permanent Coverage

Unlike term life insurance which provides coverage for a specified period, IUL offers lifelong coverage, ensuring that beneficiaries receive a death benefit no matter when you pass away.

 

Downsides Of Indexed Universal Life Insurance

Complexity

IUL policies can be complex to understand, especially with various components like caps, participation rates, and floors. This requires you to do thorough research or work with a knowledgeable advisor.

Cost

Premiums for IUL are generally higher than term life insurance due to the investment component and associated fees.

Capped Growth

While IULs offer protection against market downturns, they also cap the potential growth. So, if the market has an exceptionally good year, you might not fully benefit from that growth.

Fees and Charges

IUL policies come with various fees such as premium loads, cost of insurance, policy fees, and potential surrender charges. These can eat into the potential returns of the cash value component.

Potential for Lower Returns

If the stock market remains stagnant or grows minimally over extended periods, the returns on an IUL policy might not fare well against other investment vehicles, especially after accounting for fees.

It’s essential for you to weigh these pros and cons against your personal financial situation, needs, and risk tolerance when considering an IUL policy.

IUL vs Other Policies

Choosing between different types of life insurance policies can be confusing. Here’s a comparison of Indexed Universal Life and three other popular types of policies to help you select a policy that best meets your needs::

IUL v whole life insurance

Compared to whole life, Indexed Universal Life offers a distinct advantage in terms of premium flexibility. You can adjust your premium payments based on your current financial situation, providing a level of adaptability.

Another consideration is that the cash value growth in IUL is closely tied to a selected market index, such as the S&P 500. This linkage means that there’s potential for higher, albeit capped, returns. A standout feature of IUL is its downside protection; even in a poor market, the policy has a guaranteed minimum interest rate, ensuring the cash value isn’t negatively impacted by market declines.

On the other hand, Whole Life insurance operates with fixed premiums, ensuring you pay a consistent amount throughout the policy’s duration. This consistency offers predictability but lessens flexibility. The cash value component in a whole life policy grows at a guaranteed, predetermined rate set by the insurance company.

While this guarantees stability in growth, it might sometimes offer returns that are lower than potential market-linked growths.

IUL vs term life insurance

Indexed Universal Life insurance policies, as previously mentioned, offer flexibility in premium payments. This adaptability allows you to adjust your contribution based on your financial standing at any given time. The cash value growth in IUL is intrinsically linked to a selected market index, offering the possibility of higher returns, though there’s a cap on maximum growth.

Additionally, the IUL policy offers protection against market downturns through its guaranteed minimum interest rate, ensuring that the cash value is safeguarded against market slumps.

In contrast, Term Life insurance is more straightforward. It provides life insurance coverage for a specified term, such as 10, 15, 20, or 35 years. If you pass away within this term, a death benefit is paid out to your beneficiaries. Premiums for term life are generally lower than those for permanent life insurance types, making it an affordable choice for many.

However, there’s no cash value component in term life, and once the term ends, coverage ceases unless the policy is renewed or converted to a permanent policy.

IUL vs variable life insurance

Indexed Universal Life (IUL) insurance is characterized by its flexible premium payments, allowing you to adjust your contributions based on your financial circumstances. The unique aspect of IUL is its cash value growth, which is tied to a market index like the S&P 500.

While this provides the potential for higher returns, there’s a cap on the maximum growth. Nonetheless, IUL offers a safety net with its guaranteed minimum interest rate, ensuring that the cash value is not detrimentally affected by market downturns.

Variable life insurance, on the other hand, offers a death benefit and a cash value component that can be invested in various sub-accounts, similar to mutual funds. You get to choose where to allocate the cash value among these investment options.

As a result, the cash value and, in some policies, the death benefit can fluctuate based on the performance of these investments. Unlike IUL, there’s no cap on the potential growth, but there’s also no guaranteed minimum, making it riskier in terms of investment.

Is An IUL Policy Right for Me?

Deciding if an Indexed Universal Life (IUL) policy is right for you involves a careful evaluation of your long-term financial goals and risk tolerance. IUL policies offer a unique blend of life insurance coverage and potential cash value growth tied to market indices.

For individuals seeking a balance between a life insurance death benefit and an investment component, IUL can be an attractive option. The policy’s flexibility in premium payments can also be beneficial for those whose financial situations might fluctuate over time.

However, it’s important to understand that while there’s a cap on the potential growth, there’s also a floor, which offers some protection against negative market performance.

When considering an IUL policy, you need to assess your investment horizon, financial needs, and understanding of the market-linked growth component. It’s also important to consider the costs associated with the policy, as IULs can sometimes have higher fees than other life insurance products.

How to Buy IUL

Here's a simple 3-step process for purchasing an Indexed Universal Life (IUL) policy:

Research and Understand Your Needs

Before diving into the process of purchasing an IUL policy, take the time to understand its features, benefits, and potential drawbacks. This involves recognizing how the policy works, its investment component linked to market indices, and the flexibility it offers in terms of premium payments. Reflect on your financial goals, risk tolerance, and long-term objectives.

1

Compare Providers and Policies

Once you have a clear understanding of IUL, start exploring different insurance providers that offer this product. Each provider might have variations in terms of participation rates, caps, and premium flexibility.

Collect quotes from multiple insurers, review the policy details, and understand the fees involved. While comparing, focus on the company’s reputation, financial strength, and customer service in addition to the policy specifics.

2

Complete the Application and Underwriting Process

After selecting a provider and a specific IUL policy that aligns with your needs, initiate the application process. This typically involves filling out a detailed questionnaire about your health, lifestyle, and financial situation. The insurance company will then conduct an underwriting process, which might include a medical exam, to assess the risk and determine the policy’s terms and premiums.

3

FAQs

Is Indexed Universal Life Insurance a good choice?

Indexed Universal Life Insurance offers a combination of life insurance coverage and potential cash value growth tied to market indices. Its suitability depends on individual financial goals, risk tolerance, and insurance needs.

Is IUL better than a 401k?

IUL and 401k serve different purposes. While IUL provides life insurance with an investment component, a 401k is a retirement savings plan with potential tax advantages. The better option depends on individual financial objectives and priorities.

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