What Is Indexed Universal Life Insurance (IUL)?
Indexed universal life (IUL) insurance is a type of permanent life insurance that offers a cash value component alongside a death benefit. This unique insurance product allows policyholders to earn interest on their cash value by tracking a chosen stock market index, such as the Nasdaq-100 or the S&P 500. Additionally, policyholders have the flexibility to allocate their funds between a fixed-rate account and an equity-indexed account based on their preferences.
While the interest rate from the equity index account can fluctuate, IUL policies provide an interest rate guarantee to limit potential losses. These policies are less volatile than variable universal life insurance because they do not directly invest in equity positions, making them a balanced option for those seeking growth potential with controlled risk.
Key Takeaways
- Indexed universal life (IUL) insurance allows policyholders to allocate cash value between fixed-rate and equity-indexed accounts.
- IUL is a form of permanent life insurance with flexible premiums and death benefit options, similar to universal life insurance.
- IUL policies can track well-known equity indexes like the S&P 500 or Nasdaq-100 to earn interest credits.
- These policies offer a balance between capped returns and guaranteed minimum interest rates.
How Does Indexed Universal Life (IUL) Insurance Work?
Similar to universal life insurance, IUL policies feature adjustable premiums and the ability to modify the death benefit. The distinguishing factor of IUL is the investment strategy for the cash value.
When securing an indexed universal life insurance policy, the insurer assists in selecting an index to link the cash value account to, affecting both the cash value growth and death benefit. Premium payments cover insurance costs, fees, and contribute to the cash value.
The cash value accrues interest based on index gains, without direct stock market investments. Policyholders can potentially borrow against the accumulated cash value, with unpaid loans deducted from the death benefit.
Key Features
- Permanent coverage with flexible premiums and death benefit adjustments.
- Potential cash value growth through an equity index account.
- Allocation options between fixed interest and equity-indexed accounts.
- Guaranteed minimum interest rates and capped returns.
- Utilization of cash value to cover or supplement premiums without impacting the death benefit.
Policyholders may have the choice to designate multiple indexes for their policy.
Policyholders can determine the percentage allocation to fixed and indexed accounts. The index’s monthly performance affects interest crediting, providing potential growth to the policyholder.
Indexed universal life insurance typically guarantees a minimum fixed interest rate and offers various benchmark equity indexes to track for potential returns.
IULs serve as a suitable option for individuals seeking permanent life insurance protection while also capitalizing on potential cash accumulation through an equity index. Common uses include key person insurance for business owners, estate planning, or premium-financing strategies.
Example of Indexed Universal Life Insurance
To illustrate, consider an IUL policy tied to an index that gained 6% over a month. The interest earned is credited to the cash value based on a predetermined participation rate, providing potential growth to the policyholder.
IUL policies offer a less risky alternative than variable life insurance due to the absence of direct stock market investments, providing a balanced investment approach.
Advantages and Disadvantages of IUL Insurance
While not suitable for everyone, IUL policies present a viable option for individuals seeking permanent life insurance with an interest-earning cash component and tax-free death benefits. While pricier than term life insurance, IUL offers lifelong coverage, potential cash value growth, and borrowing options.
Advantages
- Flexible premiums and death benefits adjustments.
- Tax-deferred cash value growth.
- Investment flexibility and control over risk exposure.
- Permanent tax-free death benefits.
- Accessible cash value regardless of age.
- No annual contribution limitations.
Disadvantages
- Capped accumulation percentages.
- Suitability for larger policy face values.
- Interest credited based on a variable equity index.
- Exclusion of stock dividends in growth calculations.
- Management fees impacting cash value accumulation.
Is Indexed Universal Life Insurance (IUL) a Good Investment?
Indexed universal life insurance offers a cash value accumulation option linked to a market index, potentially earning modest returns. However, primarily, it serves as a life insurance policy rather than an investment tool.
Can You Lose Money in an Indexed Universal Life Insurance Policy (IUL)?
Losses in an IUL policy are unlikely due to principal protection guarantees against market downturns. Nevertheless, there are often limitations on the maximum earnings possible.
Is Indexed Universal Life Insurance (IUL) Better Than a 401(K)?
IUL may not be superior to a 401(k) for most individuals when saving for retirement. While IULs benefit high-net-worth individuals seeking tax advantages, a 401(k) remains a more favorable investment vehicle due to lower fees and premium costs, coupled with unlimited earning potential.
What Are the Cons of Indexed Universal Life (IUL)?
Drawbacks of IUL policies include capped cash accumulation, potential volatility due to equity index reliance, and limitations on interest earnings in a bearish market. Premium costs and fees make IULs more expensive and less cost-effective compared to term life insurance.
Is IUL Better Than Whole Life?
Comparing IUL to whole life insurance, IUL offers an investment component tied to an equity index and flexible premiums, while whole life provides guaranteed death benefits and stable premium amounts. The choice depends on risk tolerance and long-term financial objectives.
The Bottom Line
Indexed universal life (IUL) insurance blends a cash value component with a death benefit, enabling policyholders to potentially earn interest through an equity index. While offering growth potential, IUL policies have limitations on cash accumulation and bear market risks.
As a life insurance product, IUL policies are not recommended as primary retirement savings vehicles. Individuals seeking maximal investment opportunities may find a 401(k) more beneficial due to lower costs and unrestricted earnings potential.
It is important to note that Investopedia does not offer financial advice or services. Consider your individual investment goals, risk tolerance, and financial circumstances when evaluating if a specific financial product meets your requirements.