Indexed universal life (IUL) insurance is a form of permanent life insurance characterized by flexibility for policyholders. With an indexed universal life insurance policy, you can choose your premiums and how much cash value to assign to a fixed-rate account or an equity-indexed account. IUL policies normally cap returns but also guarantee a minimum interest rate, providing a range of predictable returns and financial stability. Many of the best life insurance companies offer IUL policies. This guide breaks down how IULs work and will help you decide if it’s a good option for you.
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What Is Indexed Universal Life Insurance (IUL)?
IUL insurance offers a cash value component as well as a death benefit. Insurers decide which stock market index is tied to the cash value account of the policy. These indexes are often the S&P 500 index or the Nasdaq Composite. Cash value funds typically earn a variable rate of interest but are also characterized by interest rate guarantees. Some insurers also offer fixed rate accounts, which provide added options to manage the policy’s performance.
IUL policies can be more volatile than fixed universal life policies but offer less risk than variable universal life insurance policies because IULs do not invest in equity positions. Aside from IUL death benefits, they aren’t considered a preferred retirement savings option because they carry higher fees and premiums than other vehicles such as a 401(k). Typically, IUL policies are best for high-net-worth individuals who want to lower their taxable income.
How Does an IUL Policy Work?
An IUL policy has adjustable premiums, just like universal life insurance, but it provides enhanced flexibility by allowing policyholders to skip or underpay premiums and in some cases, adjust the death benefit. These decisions are based on how you want to invest the cash value.
When a policyholder makes a premium payment, some of that amount pays the cost of insurance on the insured’s life. After fees are paid, the remaining balance is added to the policy’s cash value. That cash value is then invested in an equity index, and the policyholder earns interest within a guaranteed range. A minimum percentage return is guaranteed, but this is offset by capping out at a top end of return, typically between 8% and 12%. This may make IULs more attractive as an investment than whole life insurance, which earns a smaller rate of return.
IULs also let you add riders such as long-term care to cover nursing home costs or an accelerated death benefit rider that pays benefits if a policyholder is terminally ill. In addition, IULs enjoy tax-free capital gains unless the policy is abandoned before it matures, which is a distinct advantage over other financial instruments that may tax capital gains upon withdrawal. Death benefits can also be passed on to beneficiaries tax-free. Plus, there are no impacts to Social Security benefits and no required minimum distributions, unlike a 401(k) or traditional IRA.
IUL Pros and Cons
Pros
- Has higher returns than other types of life insurance
- Policies can be tailored to a holder’s preferred level of risk
- Allows tax-free capital gains
- Policies do not reduce Social Security benefits
- Cash value can be used to lower or cover premiums without reducing death benefit
- Some policies may allow cash value designations in multiple indexes
- Don’t need to pay capital gains on cash value increases unless you abandon the policy before it matures
- Policies may allow emergency access to cash values, although fees will apply
Cons
- Rates of returns are capped, typically between 8% and 12%
- Returns vary based on an index and have variable premiums over time
- Must be comfortable with fluctuating returns and budgeting for potentially higher premiums
- May have higher premium, administration and commission fees than other policies
- Rates of return may underperform the stock market in upswing periods
How Interest Is Calculated With an IUL Policy
IULs offer a guaranteed minimum fixed interest rate and a choice of benchmark equity indexes to track that will create a variable return. One of the benefits of an IUL is that an insurer pays a minimum interest rate even when the benchmark index tied to the policy underperforms. Conversely, interest rate returns are capped at an upper limit.
In most cases, policyholders can decide how much of their cash value is dedicated to fixed and indexed accounts. The index values are noted at the beginning of each month and compared against the value at the end of the month. If the index increases, the interest is added to the cash value, which is credited back to a policy account monthly or annually.
This offers a protective rate of return, although that rate may not be optimal in a bull market where market returns are higher than the cap on the policy.
Adjustable Premiums and Death Benefit
The premium you pay may be adjustable depending on how you allocate your cash value. Some holders use increased cash value to offset premium amounts so they end up paying less out of pocket for the same death benefit coverage.
Death benefits are flexible in most cases, and policyholders can lower them at any time. You can also raise the death benefit amount, but you may have to pass a medical exam to meet your insurer’s standards for risks. However, many insurance policies are available with no exam requirements. We recommend asking these types of questions before committing to a policy because they can vary from insurer to insurer.
How To Know If an IUL Is Best for You
An IUL policy is a good choice if you’re looking for the potential for cash value growth while also seeking protection if the stock market falls. Returns are capped on both the high side and downside, which offers a safe haven but also limits the opportunity for outsized growth potential.
It’s also a good fit for people who want flexibility in how to allocate cash value based on their risk profiles. More conservative policyholders often have the option of placing cash value into fixed rate return indexes, while more aggressive holders can allocate more funds tied directly to indexes that are tied to market conditions. Cash value accumulation is also an important benefit because it can be used to pay premiums without negatively impacting the death benefit. Fees and commissions tend to be higher with IUL policies, so it’s important to factor in those expenses when deciding if an IUL is the best option.
IUL vs. Whole Life
Deciding which type of permanent life insurance policy is best will depend on the policyholder’s long-term retirement goals.
A whole life insurance policy is best for those who want guaranteed benefits with fixed premiums and a stable rate of return. Whole life is generally regarded as the safest and most conservative option for those who want to provide for their family after death. Whole life insurance also has a cash value component that may accumulate on a tax-advantaged basis.
IUL policies are best for those who want flexibility in how they manage their policy, including the amount of the death benefit, the opportunity for more growth and how to allocate their cash value amounts. IULs allow policyholders to adjust or skip premium payments when cash value amounts are sufficient, but it should never be considered the cheapest option for life insurance.
Conversely, whole life premium costs are set for the entire life of the policy. Fees and commissions are higher for IUL policies because they are more complicated to oversee and manage.
Read more: Top life insurance companies for whole coverage
Is IUL Worth It?
IUL insurance offers some important advantages as part of an overall retirement investment strategy. You can create flexible premiums and have the option of increasing or decreasing a death benefit in most situations. The cash value of the policy grows tax-deferred and can be used to pay for premiums. Over time this may even allow you to stop making premium payments while still keeping the policy in good standing.
Policyholders usually have the option of controlling the amount of payments going into equity-indexed accounts or fixed-rate accounts. That flexibility also extends to adding optional riders that include no-lapse and guaranteed death benefits. IUL policies also have no annual contribution limits and have reduced risk because they are tied to indexes and not individual stocks, providing a hedge against harsh downtrends.
Frequently Asked Questions About IUL Policies
IUL policies offer several attractive benefits for policyholders, but there are some downsides as well. Since an IUL is tied to a market index, If the tracked index goes down, no interest is credited to the cash value. Although flexibility is an attractive benefit, you may pay for that privilege through higher fees, commissions, surrender charges and other add-on costs compared to other types of policies.
IUL policies have a guaranteed base return, but they also cap how much money you can accumulate, usually less than 100% of the policy value. Also, because of a cap on the rate of return, IULs may be less attractive in times when indexes experience high rates of return compared to other investment accounts that have an unlimited upside.
In most cases, an IUL policy doesn’t measure up well against a 401(k) when saving for retirement. A 401(k) is a better investment vehicle because it doesn’t carry the high fees and premiums of an IUL. Plus, there is no cap to the upside amount an investor can earn, which is not the case for an IUL policy. However, IUL policies are more advantageous for high-net-worth individuals looking to reduce their taxable income while also seeking protection for their loved ones.
While both types of policies are best for high-income earners, IUL and variable life insurance policies do have some distinct differences.
IUL policies offer a flexible death benefit and generally accumulate cash value growth at a slower pace. Variable life policies have a guaranteed death benefit and a greater potential for higher cash value growth. The other primary difference is that IUL policies have adjustable premium payments based on how cash value is allocated, while variable policies have fixed premium payments to allow for consistent budgeting.
Variable life policies also tend to have higher management fees than IUL policies. Also, it’s possible to add cash value or premiums paid to increase the death benefit for both types of policies, but IULs offer the flexibility of lowering the death benefit as your needs change.
The primary difference is that the death benefit will be the multiple of the dollars you place into an IUL policy. With an annuity, you may not have access to a death benefit rider. And if you do, the death benefit may only equal the value of the contract.
Fixed annuities also protect against market downturns. With an IUL, your returns are linked to an index’s performance, which can negatively impact the rate of return.
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