Indexed Universal Life
What is an Indexed Universal Life Policy
Indexed universal life (IUL) insurance policies can help you to build wealth while leaving behind a death benefit for your loved ones. These policies put a portion of the policyholder’s premium payments toward annual renewable term life insurance, with the remainder added to the cash value of the policy after fees. On a monthly or annual basis, the cash value is credited with interest based on increases in an equity index. While IUL insurance may prove valuable to some, it’s important to understand how it works before purchasing a policy.
How It Works
IUL insurance is often pitched as a cash value insurance policy that benefits from the market’s gains tax-free—without the risk of loss during a market downturn. When you purchase an IUL insurance policy, you’re getting permanent coverage as long as premiums are paid. Your policy includes a death benefit, which is paid out to your named beneficiary or beneficiaries when you pass away. But the policy can also increase in value during your lifetime through a cash value component.
The cash value portion of your policy earns interest based on the performance of an underlying stock market index. For example, returns may be linked to the Standard & Poor’s (S&P) 500 composite price index, which tracks the movements of the 500 largest U.S. companies by market capitalization. As the index moves up or down, so does the rate of return on the cash value component of your policy.
The insurance company that issues the policy may offer a minimum guaranteed rate of return. There may also be an upper limit or rate cap on returns. IUL insurance is riskier than fixed universal life insurance policies, which offer a guaranteed rate of return. But it’s less risky than variable universal life insurance, which allows you to invest money directly in mutual funds or other securities.
Advantages of IULs
As is the case with any type of universal life insurance, it’s vital to thoroughly research any potential firms to ensure that they’re among the best universal life insurance companies currently operating. With that in mind, here’s a look at some of the chief advantages of including IUL in your financial plan.
1. Higher Return Potential
These policies leverage call options to gain upside exposure to equity indexes without the risk of losses, while whole life insurance policies and fixed universal life insurance policies provide only a small interest rate that may not even be guaranteed. Of course, the annual return that you see with an IUL insurance policy will depend on how well its underlying index performs. But your insurance company can still offer a guaranteed minimum return on your investment.
2. Greater Flexibility
IUL insurance can offer flexibility when putting together a policy that’s designed to meet your investment goals. Policyholders can decide how much risk they would like to take in the market, adjust death benefit amounts as needed, and choose among a number of riders that make the policy customizable to their needs. For example, you may choose to add on a long-term care rider to cover nursing home costs if that becomes necessary.
3. Tax-Free Capital Gains
Policyholders do not pay capital gains on the increase in cash value over time unless they abandon the policy before it matures, whereas other types of financial accounts may tax capital gains upon withdrawal. This benefit extends to any loans that you may take from the policy against your cash value. Having a ready source of cash that you can borrow against may be appealing if you want to avoid triggering taxes and penalties with an early withdrawal from a 401(k) or IRA.
4. No Social Security Impact
Social Security benefits may be an important source of income in retirement. You can begin taking Social Security as early as age 62 or defer benefits up to age 70. Taking benefits ahead of your full retirement age can shrink your benefit amount, as can working while receiving benefits. You’re only allowed to earn so much per year prior to reaching full retirement age before your benefits are reduced. Cash value accumulation from an IUL insurance policy wouldn’t count toward the earnings thresholds, nor would any loan amounts that you borrow. So you could take a loan against your policy to supplement Social Security benefits without detracting from your benefit amount.
5. Death Benefit
IUL insurance, like other types of life insurance, can provide a death benefit for your loved ones. This money can be used to pay funeral and burial expenses, cover outstanding debts such as a mortgage or co-signed student loans, fund college costs for children, or simply pay for everyday living expenses. This death benefit can be passed on to your beneficiaries tax-free.