With a resent interest in IUL policies, in this article we will discuss the benefits and risks of IUL policies.

There are two main types of permanent life insurance on the marketplace and that is Whole Life and Universal Life. Both polices are a permanent life insurance solutions with permanent death benefit and cash value component that grows tax deferred. Whole life insurance provides more guarantees, with fixed premiums and a guaranteed death benefit along with a guaranteed rate of cash value growth. On the other hand, Universal life insurance (UL) is often more cost-efficient due to its flexible premiums.

The Indexed Universal Life (IUL) is a variation of Universal Life, because of the flexible premium flexibility with the potential for greater cash value growth that’s tied to a market index. Traditional UL policies grow at a guaranteed crediting rate. Indexed Universal Life also offers more downside risk protection compared to another type of policy called Variable Universal Life (VUL), which lets policyholders invest more directly in market-type securities while assuming all investment risk. 

Universal Life policy provides permanent death benefit protection plus a cash value component. Policy holders can raise or lower their premium payments within a certain range and the death benefit is also adjustable. Flexible premiums can be a good fit for people with fluctuating incomes, because it makes the advantages of permanent coverage more easily attainable. These UL policies can provide guaranteed cash value growth like a Whole Life policy, while providing the same kinds of tax deferral, policy loan features, and death benefit. But it’s also important to note that minimum premium payments mean less cash value for growth, and expenses can ultimately erode its value, resulting in a need to pay higher premiums in later years or reduce the death benefit to keep the policy in force as the cost of insurance increases as we age.

The key difference between UL, Indexed UL and Variable UL lies in how cash value accumulation is calculated. In a UL policy, the cash value is guaranteed to grow at an interest rate based on either the current market or a minimum interest rate, whichever is higher. 

People looking for potentially higher returns sometimes choose a variable universal life (VUL) policy. These policies give you the option to tie cash value growth to “subaccount” investment funds and you can decide how much of your cash value to invest in each option.

With VUL, funds in subaccounts are subject to market risk: In a good year for the market, the value of your subaccounts (and cash value) can rise. In a bad year, the subaccount value can and will decrease.

Indexed UL offers something in between: it provides more growth potential than standard UL, with less investment risk than VUL. 

These policies let you allocate all or part of your cash value growth to the performance of a broad securities index such as the S&P 500 Index. However, unlike VUL, your money is not actually invested in the market – the index just provides a reference for how much interest the insurance credits to your account, with a floor and a cap for the minimum and maximum rates of return. While you won’t realize all the gains of your reference index, you won’t suffer any of the losses either. Since the floor is usually set at 0%, in a down year for the markets your cash value amount will remain steady or even grow slightly (because some policies set the floor above 0%).

How cash value grows in an indexed UL life insurance policy

First of all, you have to choose how you want your cash account to be allocated for growth. Each insurance company has its own selection of indices available, and you may be able to choose more than one. Generally, you’ll also be able to allocate a portion to a fixed-rate interest account.

The cap is usually max credit for a specified segment of index participation. Most policies have annual caps, but some policies may have monthly caps. Caps can change at the end of any segment.

Additionally, upside performance can be impacted by a “participation rate” set as a percentage of the index’s gain. For example, if the reference index rises 12%, and the policy’s participation rate is 50%, the amount allocated to the index would grow by 6%. Most Indexed UL policies have a participation rate set at 100% but that can change as it is not guaranteed by the insurance company.

Benefits and Risks of IUL

Benefits:

Potential for Cash Value Growth:

IUL policies allow the cash value component to grow based on the performance of a selected market index, such as the S&P 500. This provides the opportunity for potentially higher returns. 

Flexibility in Premiums and Death Benefit:

Policyholders have the flexibility to adjust premium payments and, within certain limits, the death benefit amount.

Tax Advantages:

The cash value growth in an IUL policy accumulates on a tax-deferred basis. Additionally, policy loans taken against the cash value are generally tax-free.

Protection Against Market Downturns:

While the cash value growth is linked to a market index, IUL policies typically include a minimum guaranteed interest rate or "floor," protecting the policyholder from negative returns during market downturns. 

Permanent Life Insurance Coverage:

IUL provides lifelong coverage.

Access to Cash Value:

Policyholders can access the accumulated cash value through withdrawals or loans, offering a potential source of funds for emergencies, retirement, or other financial needs. 

Risks:

Market Performance Limitations:

While IUL policies are tied to market indices, they often come with cap rates that limit the maximum return and participation rates that determine how much of the index gain is credited to the policy. These limitations can restrict cash value growth, especially during periods of strong market performance.

Policy Charges and Fees:

IUL policies include various charges, such as premium expense fees, administrative costs, and optional rider fees. Over time, these charges can significantly erode the cash value of the policy.

Increasing Cost of Insurance:

As the insured ages, the cost of insurance within the policy increases. If the cash value doesn’t grow enough to cover these rising costs, additional premiums may be required to keep the policy active.

Policy Lapse Risk:

If the cash value becomes insufficient to cover the Cost of insurance and other fees, and no additional premiums are paid, the policy may lapse, resulting in a loss of coverage.

Complexity and Management:

IUL policies are complex financial products that require careful management and a solid understanding of their features. Misunderstanding or mismanaging the policy can result in outcomes that fall short of expectations.

Potential for Policy Not Lasting a Lifetime:

Although IUL policies are marketed as permanent life insurance, several factors—such as insufficient funding or rising costs—can cause the policy to lapse before the insured’s lifetime, particularly if premiums are not managed properly.

IIs indexed universal life insurance right for you?

An IUL policy can be a powerful addition to your overall financial strategy – especially if you are a high-earner looking for additional tax-efficient savings vehicles. If you think it could be the right life insurance policy for you, we suggest getting professional guidance. Discuss your situation with a financial professional experienced in helping people get permanent life protection.

An Indexed Universal Life (IUL) is not considered a security. Premium and death benefit types are flexible. It’s crediting rate is based on the performance of a stock index with a cap rate (i.e.10%), a floor (i.e.0%) and a participation rate (i.e., 100%). This type of universal life policy may lapse due to low or negative performance of the stock index, inadequate funding, and increasing cost of insurance rates.

Material discussed is meant for general informational purposes only and is not to be construed as a recommendation or advice. Please note that individual situations can vary therefore, the information should be relied upon only when coordinated with individual professional advice. The primary purpose of any life insurance policy is its death benefit. Whole Life insurance is intended to provide death benefit protection for an individual’s entire life. With payment of the required guaranteed premiums, you will receive a guaranteed death benefit and guaranteed cash values inside the policy. Guarantees are based on the claims-paying ability of the issuing insurance company. Dividends are not guaranteed and are declared annually by the issuing insurance company’s board of directors. Any loans or withdrawals reduce the policy’s death benefits and cash values and affect the policy’s dividend and guarantees. Whole life insurance should be considered for its long-term value. Early cash value accumulation and early payment of dividends depend upon policy type and/or policy design, and cash value accumulation is offset by insurance and company expenses. 7463663.1