Understanding Indexed Universal Life Insurance
Indexed universal life (IUL) insurance is a type of permanent life insurance that offers a death benefit similar to standard universal life insurance, but with a cash value component that works differently. The distinguishing feature of IUL insurance is that some or all of its cash value is tied to the performance of a stock or bond index.
IUL insurance policies are complex and can come with more ups and downs than many other types of life insurance. For a savvy investor looking for a policy with flexibility, IUL could be a good fit. However, if you’re simply looking for permanent coverage with guarantees, a whole life policy is a better option.
What is Indexed Universal Life Insurance (IUL)?
Indexed universal life insurance is a type of permanent coverage, which means it can last your entire life and build cash value. Unlike other types of universal life insurance, an IUL insurance policy places the cash value in sub-accounts that mirror a stock index, such as the S&P 500.
Similar to other universal life policies, IUL insurance gives policyholders the flexibility to adjust their premiums and life insurance death benefit as needed.
Key Facts About Indexed Universal Life Insurance
Here's a summary of the key aspects of IUL insurance:
Read also: Comprehensive Ranking: Women's College Basketball
- Costs: Generally less expensive than whole life insurance.
- Benefits: Lifelong coverage and cash value you can borrow against or withdraw.
- Best for: Those with risk tolerance who've maxed out other tax-advantaged accounts.
Pros and Cons of Indexed Universal Life
Like any financial product, IUL insurance has its advantages and disadvantages.
Pros
- Stock Market-Driven Returns: With indexed accounts, the cash value grows when the market grows, and that growth often builds tax-deferred. When your selected index gains value, so too does your policy's cash value. Your IUL cash value will also have a minimum interest rate that it will always earn, regardless of market performance.
- Control: You can increase or decrease your premium payments, depending on your need for coverage, the growth of your cash account, and your finances. You can also increase or decrease your policy's death benefit, although you may need to complete a medical exam if you want to boost it.
- Flexibility: An IUL policy functions the same way as a traditional universal life policy, with the exception of how its cash value earns interest.
Cons
- Risk: The indexes may not rise as quickly as projected. If this happens, the return on your investment could fail to meet your expectations. That could lead to owing extra money to keep your policy from lapsing. If all you want is a guaranteed payout and some cash value, a whole life insurance policy may be a better option.
- Effort: You’ll need to monitor your policy closely. During periods of low returns, you may need to pay more into your account to prevent your policy from lapsing.
- Capped Returns: Caps and participation rates limit you from fully sharing in the success of the market. Plus, they can come down over time, further limiting your returns.
- Fees: IUL coverage fees can increase over time and may eat into the payments you make or the value of your cash account.
- Complexity: Indexed universal life is complicated and requires a more hands-on approach to managing the policy.
How Indexed Universal Life Insurance Works
Indexed universal life insurance works similarly to universal life. You pay a premium in exchange for potentially lifelong coverage and the opportunity to build cash value over time. Part of your premium payment goes toward the cost of insurance - i.e., paying out the death benefit - and other fees. The rest is added to your cash value.
The cash value of IUL can grow based on the performance of a stock market index, so it might rise more quickly than other life insurance options - but can also be riskier and harder to manage.
Adjustable Premiums and Death Benefit
As with universal life, IUL insurance premiums are adjustable. If you ever decide to skip a premium payment or underpay, the cost of insurance and policy expenses are deducted from your cash value. You may also be able to adjust the death benefit amount if your needs change. However, you may be asked to complete a life insurance medical exam if you apply to increase your policy’s death benefit.
Cash Value
The cash value in IUL insurance policies can earn or restrict interest in three ways:
Read also: High School Diploma Jobs
- A fixed interest rate.
- The performance of stock and bond indexes.
- The participation rate.
You can choose to put the cash value in a fixed account, indexed account, or a combination of both.
1: Fixed Accounts
Fixed accounts grow at a fixed rate set by the insurer.
2: Indexed Accounts
These accounts are slightly more complex. The cash value is placed in one or more sub-accounts that mirror the performance of a stock or bond index, such as the S&P 500. You can choose which accounts to invest in based on what the insurer has to offer. The insurer then pays interest to policyholders based on the performance of the index. As the index goes up, the account earns interest. If the index drops, the account earns less or nothing.
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. It's often set at 0%, which means the account won’t suffer losses if the market crashes.
The cap is 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. For example, if the cap is 10% and the index rises by 12%, you’ll earn interest of only 10%. Unlike the floor, your insurer can change the cap while the policy is in force.
Read also: Improve Your English with These TV Shows
3: Participation Rate
Caps are not the only way an IUL policy can restrict interest. There's also the participation rate. This rate dictates whether the cash value that you tied to a market index can fully “participate” in the gains of that index. A participation rate below 100% will further limit the interest you can earn. For example, if the index gain is 12% and the cap is 10% (as outlined in the above example), but your participation rate is 80%, you’ll earn only 8%. The insurer can adjust the participation rate during the life of the policy.
There are several methods insurers use to calculate gains in indexed universal life policies, such as the Daily Average method, the Monthly Point-to-Point method, and the Annual Point-to-Point method. Methods vary among policies and insurers. Be sure to carefully review the information provided and then double-check your understanding with your agent about the method used.
The Cost of Indexed Universal Life Insurance
The exact cost of your IUL policy will depend on factors such as your age, health, smoking status, and coverage amount. Below are average annual premiums for a $500,000 IUL policy for non-smokers in excellent health.
| Issue age | Men | Women |
|---|---|---|
| 20 | $2,584 | $2,221 |
| 30 | $3,612 | $3,210 |
| 40 | $5,942 | $5,182 |
| 50 | $10,132 | $8,564 |
| 60 | $18,309 | $15,752 |
Source: Covr Financial Technologies. Lowest three rates for each age averaged, as of November 8, 2024.
Indexed Universal Life vs. Other Life Insurance Types
To better understand IUL insurance, let's compare it to other common types of life insurance.
Indexed Universal Life vs. Whole Life Insurance
| Feature | Whole life | Indexed universal life |
|---|---|---|
| Policy duration | Permanent. | Permanent. |
| Cash value earnings calculation | Fixed rate. | Stock and bond indexes, as well as fixed interest rate options. |
| Flexible premiums and death benefit | No. | Yes. |
| Cash account value can decline | No. | Yes, if growth is low, fees are high and you pay minimum or no premiums. |
| Cost | Generally more expensive. | Generally less expensive. |
| Predetermined schedule | Whole life insurance builds cash value on a predetermined schedule | You don't need to worry about the performance of certain market indexes, and the premium will likely be less expensive with fewer fees than an IUL. However, you won't have the flexibility of adjusting premiums. |
Indexed Universal Life vs. Universal Life Insurance
| Feature | Universal life | Indexed universal life |
|---|---|---|
| Policy duration | Permanent. | Permanent. |
| Cash value earnings calculation | Rate set by your insurer (which may change frequently). | Stock and bond indexes, as well as fixed interest rate options. |
| Flexible premiums and death benefit | Yes. | Yes. |
| Cash account value can decline | Yes, if growth is low, fees are high and you pay minimum or no premiums. | Yes, if growth is low, fees are high and you pay minimum or no premiums. |
| Cost | Generally less expensive. | Generally more expensive. |
Indexed Universal Life vs. Term Life Insurance
| Feature | Term life | Indexed universal life |
|---|---|---|
| Policy duration | The length of the policy term, such as 10, 20, or 30 years. | Permanent. |
| Cash value earnings calculation | No cash value. | Stock and bond indexes, as well as fixed interest rate options. |
| Flexible premiums and death benefit | Premiums and death benefit are usually fixed. | Yes. |
| Cash account value can decline | No cash value. | Yes, if growth is low, fees are high and you pay minimum or no premiums. |
| Cost | Significantly less expensive. | Significantly more expensive. |
Indexed universal life vs. Variable life insurance
Variable life insurance allows for even more flexibility than indexed universal life insurance, making it more complicated. Unlike an indexed policy, a variable policy's cash value may be entirely dependent on specific stocks you select. While you might have a fixed minimum death benefit on your variable policy, the performance of your cash value could drastically increase or decrease your beneficiaries' total payout upon your passing. Your premium could also be affected by how the variable portion performs, with lower performance leading to a higher cost.
Understanding IUL Policy Illustrations
When you sit down to discuss IUL policy options with an agent, you’ll be shown illustrations. These are projections of the policy’s cash value growth, based on predicted interest rates, fees, payments, caps, participation rates, and loans. It’s easy to see these as accurate forecasts of the future, but they are not - they’re estimates. After all, no one knows for certain how the stock and bond markets are going to perform or what adjustments the insurance company will make.
When considering an indexed universal life policy, make sure to ask how the interest rates, fees, caps, participation rates, or premiums could affect your policy’s performance.
Is IUL Right for You?
You may want to consider indexed universal life insurance if:
- You want life insurance coverage that can last your whole life.
- You’re willing to monitor the policy closely and accept some risk to earn more interest for your cash value.
- You feel comfortable that you’ll be able to pay the policy premiums over the long term.
- You’ve already put the maximum amount into other tax-advantaged investment accounts.
IUL policies are more common among high-net-worth individuals who are looking for supplementary retirement income or life insurance. Keep in mind that higher premium costs and potential fees make IUL policies more expensive than other types of life insurance. If you're considering buying an indexed universal life policy, first speak with a financial advisor who can explain the nuances and give you an accurate picture of the actual potential of an IUL policy. You can get a universal life insurance quote online. You'll answer some questions; then you'll choose your death benefit amount and other policy details.
Companies That Offer IUL Insurance
All of the companies below offer indexed universal life and earned at least 4 stars out of 5 for overall performance. NerdWallet’s ratings are determined by our editorial team and are based on the company as a whole, not individual products. The scoring methodology takes into account consumer experience, complaint data from the National Association of Insurance Commissioners, and financial strength ratings.
NerdWallet's star rating methodology: NerdWallet’s life insurance ratings are based on consumer experience, complaint index scores from the National Association of Insurance Commissioners for individual life insurance, and weighted averages of financial strength ratings, which indicate a company’s ability to pay future claims. To calculate each insurer’s rating, we adjusted the scores to a curved 5-point scale. These ratings are a guide, but we encourage you to shop around and compare several insurance quotes to find the best rate for you. NerdWallet does not receive compensation for any reviews. Read our editorial guidelines.
Insurer complaints methodology: NerdWallet examined complaints received by state insurance regulators and reported to the National Association of Insurance Commissioners in 2021-2023. To assess how insurers compare with one another, the NAIC calculates a complaint index each year for each subsidiary, measuring its share of total complaints relative to its size, or share of total premiums in the industry. To evaluate a company’s complaint history, NerdWallet calculated a similar index for each insurer, weighted by market shares of each subsidiary, over the three-year period. NerdWallet conducts its data analysis and reaches conclusions independently and without the endorsement of the NAIC. Ratios are determined separately for auto, home (including renters and condo) and life insurance.
Frequently Asked Questions
What is indexed whole life insurance?
Indexed whole life insurance isn’t an actual policy. You might be thinking of indexed universal life insurance. With this type of life insurance, the interest rate at which the cash value grows is linked to the performance of a stock index, such as the S&P 500. While your policy won’t lose value if the stock market doesn’t perform well, annual returns will be capped, so you won’t be able to take full advantage of a strong market either.
What are the differences between whole life and indexed universal life insurance?
There are key differences between these permanent policies. The cash value within a whole life insurance policy grows at a fixed rate, meaning the annual returns are guaranteed and predictable. With indexed universal life insurance, the cash value interest rate is typically tied to the performance of a stock index, so returns might fluctuate. IUL policies also offer flexible death benefits and premiums; whole life policies don't.
How can I buy indexed universal life insurance?
You can purchase an IUL policy online, through a life insurance agent, or directly from an insurer. Check out the best life insurance companies as a starting point, and be sure to compare quotes from multiple insurers to get the coverage you need at the best possible price.
Should I invest money in my 401(k) or an indexed universal life insurance policy?
For the purposes of retirement savings, it is important to prioritize your 401(k) or IRA, especially if your employer offers matching contributions. Buying an indexed universal life policy should only be done in consultation with a life insurance agent and when you’ve put the maximum amount in other types of tax-advantaged accounts.
Is indexed universal life insurance worth it?
Indexed universal life insurance can be worth it for some wealthy individuals and experienced investors, but it comes with increased risk and requires careful attention to managing the policy. If you want lifelong coverage that builds cash value and has a guaranteed death benefit, whole life insurance may be a better fit. Term life insurance is the most affordable choice and provides suitable coverage for most people.
tags: #indexed #universal #life #insurance #explained
