Indexed Universal Life Insurance

Everything You Need To Know About Indexed Universal Life Insurance

What Is Indexed Universal Life (IUL) Insurance?

The indexed universal life, also known as variable universal life, is one type of whole life insurance that offers both investment and protection benefits.

The IUL provides for a guaranteed minimum level of coverage in exchange for a premium paid overtime. This means you can build up your cash values without having to pay any upfront fees. You may be able to use these funds toward retirement goals like purchasing a home or paying off debt.

How Does Indexed Universal Life (IUL) Insurance Work?

When a premium is paid, a portion pays the cost of insurance based on the life of the insured. Any fees are paid, and the rest is added to the cash value. The total amount of cash value is credited with interest based on increases in an equity index (but it is not directly invested in the stock market).

Some policies allow the policyholder to select multiple indexes. is usually offer a guaranteed minimum fixed interest rate and a choice of indexes. Policyholders can decide the percentage allocated to the fixed and indexed accounts.

The value of the selected index is recorded at the beginning of the month and compared with the value at the end of the month. If the index increases during the month, the interest is added to the cash value. The index gains are credited back to the policy either on a monthly or an annual basis.

For example, if the index gained 6% from the beginning of June to the end of June, the 6% is multiplied by the cash value. The resulting interest is added to the cash value. Some policies calculate the index gains as the sum of the changes for the period, while other policies take an average of the daily gains for a month. If the index goes down instead of up, no interest is credited to the cash account.

The gains from the index are credited to the policy based on a percentage rate, referred to as the “participation rate.” The rate is set by the insurance company and can be anywhere from 25% to more than 100%. For example, if the gain is 6%, the participation rate is 50%, and the current cash value total is $10,000, $300 is added to the cash value (6% x 50% x $10,000 = $300).

IUL policies typically credit the index interest to cash accumulations either once a year or once every five years. IUL insurance policies reduce risk because no cash is directly invested in the stock market. Source: investopedia.com

Advantages of Indexed Universal Life (IUL) Insurance

IUL insurance policies offer tax-deferred cash accumulation for retirement while maintaining a death benefit. Advantages of Indexed Universal Life Insurance Policies:

• Indexing allows you to invest your savings without risking them in stocks. This means that there will always be some return even when the markets go through turbulent times.
• You don't have to worry about losing all your investment capital due to the poor performance of the stock market. You also won't lose any principal if the stock market crashes.
• If you want to diversify your investments, this type of plan offers many options. It's easy to add new funds into the mix.

Disadvantages of Indexed Universal Life (IUL) Insurance

• Cash value accumulation: Amounts credited to the cash value grow tax-deferred. Most IUL insurance policies offer a host of optional riders, from death benefit guarantees to no-lapse guarantees.
• Death benefit: This benefit is permanent, not subject to income or death taxes, and not required to go through probate.
• Disadvantages of Indexed Universal Life Insurance Policies
• No guarantee of return: Unlike whole life insurance policies that provide guaranteed returns, there is no assurance that the investment will increase over time.
• Taxes: Because the money used to purchase the policy is taxed when it leaves your hands, you may owe additional federal and state taxes on withdrawals made before retirement.
• Lack of liquidity: Withdrawals cannot occur until after the insured has died, which means they must wait until then to access their funds.

The Bottom Line

Cash value accumulation: Amounts credited to the cash value grow tax-deferred. Most IUL insurance policies offer a host of optional riders, from death benefit guarantees to no-lapse guarantees.

Death benefit: This benefit is permanent, not subject to income or death taxes, and not required to go through probate. Indexed universal life insurance has been around since the 1980s. It offers many advantages over traditional term life insurance.

However, it also comes with some drawbacks. Because there isn't a direct investment in stocks, the returns aren't always positive. Also, the rates may fluctuate depending on how well the underlying index does. In addition, the benefits are taxable when they're withdrawn. Finally, the cash value grows slowly unless you make additional investments.

Riding an Index

Indexed universal life insurance was invented by John Hancock Financial Services Inc., which launched it as part of its first index mutual fund back in 1989. It became popular because it offered investors access to both stocks and bonds through a single investment vehicle.

The idea behind indexed universal life insurance is simple: Investors buy shares in an underlying portfolio of securities such as U.S. Treasuries, corporate debt, real estate investments, and other assets.

Trying to Play It Safe

Indexed universal life insurance was invented in the 1990s when it became clear that people wanted protection without having to pay high fees for term insurance. The idea behind IUL is simple: You put up some capital — typically between 5 percent and 15 percent of your total wealth — and then get paid back over many decades based on how much the stock market goes up.

If the market rises faster than expected, you make out better; if it falls slower, you lose less.

Fees Can Drain the Policy

One problem with these types of investments is that they come with fees. Fees vary depending on how much money goes into the policy and what type of options are being bought. Some policies charge monthly management fees ranging between 0% and 1%. Others may charge higher upfront costs when the policy is purchased. Then there are transaction fees charged every time something changes in the portfolio—such as adding new securities or selling existing ones.

These fees threaten to drain your policy's cash value during adverse periods when the market or whatever index the policy is tied to plunges. If internal costs cause the policy account value to drop too much, your policy is at risk of lapsing and you'll have to pay more in premiums just to keep the policy intact.

One problem with these types of investments is fees. Indexed universal life has high upfront costs — typically between $1,000-$2,500 per person depending on how much coverage they want. Then there are ongoing expenses: commissions paid to brokers; management fees charged by the insurer; taxes levied on dividends and capital gain distributions; and any charges imposed by the broker.

In addition, some people may find themselves unable to afford the payments required under the contract when the policy matures.

The IUL Sales Problem

Insurers like Prudential charge between 3%-5% of the total amount invested annually in their IUL plans. This means that even though they're not charging anything upfront, there will still be some sort of a fee associated with the purchase.

There are two main problems with selling these products: The commissions charged by agents can add up quickly, and there isn't enough competition among insurers to drive prices lower.

For instance, the average annual cost per insured for a single-life policy with no medical benefits is about $1,500, according to the American Council of Life Insurers. For a family plan, the price tag rises to around $3,300 annually.

Dealing with the Unexpected

If your IUL doesn't perform well enough to cover its expenses, you'll likely face higher monthly payments. But there isn't any guarantee that you'll get back what you put in. The best way to protect yourself is to make sure you understand the risks involved before buying.

You should also know whether the company has been sued for fraud or misrepresentation. You might want to consider getting some advice from someone else about which companies offer good value for money.

Key Takeaways

• Indexing is the process by which an insurer increases or decreases its investment in stocks based on changes in their market value.

• The index used for this purpose can vary from company to company.

• An indexed policy may offer more flexibility than traditional term policies because you have access to your money at any time without penalty.

• You must pay premiums regardless of whether the stock market goes up or down.

Indexed Universal Life Insurance: How It Works

An indexed universal life policy is a form of whole life insurance that combines features from both term and variable life insurance. The main difference between an index universal life policy and other types of whole life insurance is how it invests your money. Index universal life insurance uses indexes such as S&P 500 for its investments instead of actively managed mutual funds. This allows you to invest in stocks without having to worry about picking individual companies. You can also choose different investment options within each fund category.

Rate Of Return Potential 

These policies leverage what is called call options to obtain possible upside gain to equity indexes without the risk of losing your investment. While whole life insurance policies and fixed universal life insurance policies provide a smaller potential of return that may not even be guaranteed. Of course, the annual return that you see with an IUL insurance policy will depend on how well its underlying index performs. But your insurance company can still offer a guaranteed minimum return on your investment.

Tax-Free Capital Gains

For example, returns may be linked to the Standard & Poor's 500 composite price index, which tracks the movements of the 500 largest U.S. companies by market capitalization.

If you have taxable income, then you'll want to consider investing in tax-free bonds instead of stocks for maximum gains. However, if you don't pay taxes now, why should you start paying them later? That's where IUL comes into play. You could use the proceeds from selling shares in an S&P 500 fund to purchase an IUL policy.

What Is Indexed Universal Life (IUL) Insurance?

The indexed universal life, also known as variable universal life, is one type of whole life insurance

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• term life insurance
• universal life insurance
• variable universal life insurance

Variable universal life insurance is a type of whole-life policy that combines the features and benefits of both term life insurance and variable life insurance. It provides protection against death, disability, or other contingencies while allowing you to invest your premium payments in an investment portfolio with tax advantages similar to those available through traditional IRAs. The flexibility offered by this product allows it to be tailored to meet individual needs.

That offers both investment and protection benefits. The IUL provides for guaranteed lifetime income payments in exchange for premiums paid overtime. These payments are made from two sources: interest on your investments and dividends from the insurer’s portfolio. As you invest more money into the plan, so does the amount of monthly payment you receive.

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