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A Guide to Indexed Universal Life Insurance

Indexed universal life insurance policies pay interest based on the movements of the stock market.
June 1, 2020
Insurance, Life Insurance
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If you’re looking for insurance that offers the flexibility of universal life and a cash account with higher growth potential, you might want indexed universal life insurance. Indexed universal life, or IUL,  gives you a chance to experience some of the upsides of the stock market while limiting risks.

While that may sound simple, there are lots of options, fees and forecasts to understand. Since IUL ties cash value to the stock market, it comes with more ups and downs than other types of life insurance. But for a savvy investor looking for a policy with a higher-touch investment arm, indexed universal life could be the perfect fit.


What indexed universal life insurance is

Indexed universal life insurance is a type of permanent life insurance that pays interest based on the movements of the stock market. It’s a subset of universal life insurance, which means policyholders can change payments and benefits as needed.

The cash accounts tied to an indexed universal life policy can grow quickly, but they can also see years without any growth. Eventually, you may even grow the account to the point you can stop making premium payments.

All of these benefits come with risks. Indexed universal life is complex, subject to shifting fees, returns and benefits. Anyone considering an IUL policy should find a fee-only advisor to help them navigate the buying and management processes.

How indexed universal life insurance works

Like other forms of permanent life insurance, indexed universal life offers a death benefit and a cash account. The death benefit is determined at the beginning of the policy, but can change. The cash account grows based on the performance of a stock index.

A stock index, such as the S&P 500 or Dow Jones Industrial Average, is a way to track a group of stocks. Insurance companies pick one or more of these and pay interest to policyholders based on the index’s performance — as value goes up, the account earns interest. If the index drops, the account earns less or nothing.

Cash accounts are first funded through premium payments. After the cost of insurance (covering your death benefit), rider charges and other fees come out, the rest is added to your cash account. If you ever decide to skip a payment or underpay, those fees can be taken directly from the account.

The amount you can earn is subject to “floors” and “caps” to help minimize large swings in interest payments. The floor is the lowest your account rate can go and is usually guaranteed for the life of the policy, but is often set at 0%.

Caps are the highest interest rate the account can earn, so if the market is up more than the cap, you’ll get credited only for the cap amount. Unlike the floor, your insurer can change the maximum rate while the policy is in force.

As an example, let’s look at an IUL policy based on the S&P 500 with a floor of 0% and a cap of 9.5%. Money that went into the cash account earns interest at the credited rate shown in the last column.

Here are the changes in the market and the resulting life insurance interest rate credited.

Index ChangeIndex FloorIndex CapCredited Rate
-4.0%0.0%9.5%0.0%
21.8%0.0%9.5%9.5%
8.9%0.0%9.5%8.9%
3.5%0.0%9.5%3.5%

You can see how the floor insulated the account from a loss at first, but in the following period, the cap limited the benefit of the index. The S&P 500 gained 21%, and policyholders saw only 9.5% of that increase.

Indexed universal life vs. other types of life insurance

 Term LifeWhole LifeUniversal LifeIndexed Universal LifeVariable Universal Life
Policy durationAny lengthPermanentPermanentPermanentPermanent
Cash value interest calculationNo cash accountFixed interest rate, non-guaranteed dividendsBond interest ratesStock indexesStocks or other investments
Flexible premiumsNoNoYesYesYes
Cash account value can declineN/ANoYes, if rates are low and fees highYes, if index growth is low and fees are highYes, if stocks perform poorly
Flexible death benefitsNoNoYesYesYes
Cost ($ = cheapest, $$$$ = most expensive)$$$$$$-$$$$$$-$$$$$$-$$$$

 

 Whole LifeUniversal LifeIndexed Universal Life
Policy durationPermanentPermanentPermanent
Cash value interest calculationFixed interest rate, non-guaranteed dividendsBond interest ratesStock indexes
Flexible premiumsNoYesYes
Cash account value can declineNoYes, if rates are low and fees highYes, if index growth is low and fees are high
Flexible death benefitsNoYesYes
Cost ($ = cheapest, $$$$ = most expensive)$$$$$-$$$$$$-$$$$

Benefits of indexed universal life

Indexed universal life insurance offers flexibility and could give you higher interest rates than other kinds of life insurance. If you’re comfortable with the risks and want to be active in the management of your insurance, this could be a nice fit.

The major benefits of IUL are:

  • Control over your death benefit and payments. You can increase or decrease payments, depending on your need for coverage, the growth of your cash account and your financial situation.
  • Stock market-driven rates of return on your cash value account. These accounts build up when the market grows, and that growth is often accumulated tax free. Since the market can outperform interest rates in other types of policy accounts, IUL policyholders have the potential to increase account values faster.

Drawbacks of indexed universal life

Indexed universal life is more complex than it may appear. While the idea of earning interest based on indexes is simple, the way that ends up working is less straightforward.

The major drawbacks of indexed universal life policies are:

  • Risk that the stock market will not rise as quickly as predictions. If this happens, the return on your investment could fail to meet your goals. That could lead to owing extra money to keep your policy from lapsing.
  • Work is required to maintain your cash value account in good health. During periods of low returns, you may need to pay more into your account, helping it regrow as quickly as possible.
  • Capped returns limit you from fully participating in the success of the market. These caps can also come down over time, further limiting your account’s potential.
  • Flexible fees, which can increase over time and eat into the payments you make or the value of your cash account.

Buying an indexed universal life insurance policy

If you’ve decided IUL is the right policy for you, there are a few things to know before talking to a life insurance agent.

The first and most important is to understand how indexed universal life is sold. When you sit down to discuss options with an agent, you’ll be shown an illustration. These are projections of the policy’s cash value growth, based on predicted interest rates, fees, payments and loans. It’s very easy to see these as accurate forecasts of the future, but they are not.

The Society of Actuaries — the folks who do the math behind insurance — has said these illustrations are problematic because “illustrations create the illusion that the insurance company knows what will happen in the future.”

Your policy may have caps that come down over time, fees that increase and periods of poor market performance that aren’t shown in the illustration.

When considering an indexed universal life policy, make sure to check how slightly lower interest rates, higher fees or smaller premium payments could affect your results.

How to know if indexed universal life is right for you

If you think the stock market is going to continue going up, and you’re excited about the floors and caps that come with indexed universal life, this may be the right pick.

Indexed universal life is for people who want to get more out of life insurance and see it as an investment. One of the best ways to fund an IUL policy is by maximizing your premium payments in the early years. Your cost of insurance will be lower then, so more money will flow into your cash account with more time to grow.

If all you want is a guaranteed payout and some cash value in retirement, IUL is overkill and a whole life policy is probably a better option.

Indexed universal life is also not for people who want total control over their investments. The cash account is invested on your behalf, with few, if any, choices for you to make. If you want more options, a variable universal life policy might be a better fit.

Companies that offer indexed universal life insurance

CompanyNotes
AIG

  • Two options, including a no lapse guarantee.

Allianz

  • Maximum death benefit of $65 million.

  • Option for beneficiaries to take payments over 10 years to get a 10% bonus to the benefit amount.

John Hancock

  • Three indexed life insurance options for differing financial needs.

  • Up to 8 index options to choose from.

Lincoln Financial

  • Two options, one with a guaranteed death benefit.

National Life Group

  • Two options for smaller and larger death benefit options.

Nationwide

  • Three options available for people with different needs.

  • Survivorship option, covering two people and paying out after the death of both.

Pacific Life

  • Four options available for people with different needs.

  • Survivorship option, covering two people and paying out after the death of both.

Prudential Financial Inc.

  • Three options, including a survivorship policy.

  • No-lapse guarantee option available.

Securian

  • Three options for different financial needs.

  • No-lapse guarantee option available.

Transamerica

  • Offers S&P 500 and Global index options.

  • Current caps above 10% and floors above 0%.

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