An IUL policy is an acronym for indexed universal life insurance. The history of universal life insurance goes back to the 1970s but the advent of IUL is fairly recent. In fact, what we now know as the modern IUL policy only dates back to the mid-1990s.
IUL policies use an index, usually a stock index, to determine the interest rate payable on the cash value of the policy. This rate is effective for the specific index period (normally not longer than one year) and then resets to a new rate with each new index segment. The interest rate-setting feature is subject to a cap and has a minimum rate under which the rate cannot go. For example, an IUL policy with a cap rate of 10% and a floor of 1% means the interest rate cannot go beyond 10% nor can it go below 1%.
The indices used to set the interest rate on an indexed universal life policy vary from company to company, but the most common indices available are: the S&P 500, Dow Jones Industry Average, NASDAQ, Euro Stoxx, and the Russell 5000 Index. The S&P index is by far the most common option on policies. These various options usually go by the name indexed account. So you might have, for example, an S&P 500 indexed account and a Dow Jones Industrial Average indexed account.
Most IUL policies offer a one-year index segment that tracks the one-year change in the index. The company uses the value of the index at the beginning of the segment and the value at the end of the segment to calculate the percentage change in the index. This change is the interest rate payable on the cash value of the policy–up to the cap rate.
If the index change is negative, the interest rate is whatever the guaranteed minimum floor rate is, which is usually 0 to 1%.
According to data from the Society of Actuaries (soa.org) the original argument for the creation of universal life insurance as a product came as a result of economic shifts in the 70s. The original concept was to combine a “flexible premium annuity with a monthly renewable term life insurance rider“. Before reading that, we never considered describing it as such but that's way clearer than any description offered by an insurance company.
Up to that point, the only type of permanent life insurance available was that provided by whole life insurance policies. But there was concern that cash value accumulation would be hindered by inflation and the death benefit guarantees offered by whole life would not entice younger generations to continue making the expensive and rigid premium payments.
You may also see this product called an Equity Indexed Universal Life Insurance policy. While this name is less common, some agents and insurance companies continue to use it.
Advantages Of An IUL Policy
Indexed universal life insurance policies have a cash value component that grows tax-deferred and can provide the policy owner with tax-free distributions. Because of the use of a stock market index to set interest payable on the cash accumulation value, IUL provides considerable upside potential for faster cash growth versus a standard whole life policy.
IUL also provides flexible premiums, which give the policy owner much more leeway over the amount of money contributed to the policy each year.
Like all universal life policies, IUL clearly details all of the fees associated with the policy. Prospective buyers can see a detailed yearly breakdown of all fees charged by the insurance company for its IUL policy.
In addition to the indexed account options, the policy owner can also choose to use some or all of his/her money in a fixed account that simply earns an interest rate declared annually by the insurance company, which is not tied to any stock index.
IUL policies also provide different death benefit options. Policy owners can choose between a level or increasing coverage amount.
Unlike a variable universal life insurance policy, which can lose money when the market goes down, indexed universal life insurance has a minimum interest rate floor, which prevents the policyholder from losing money in a market decline.
Lastly, IUL policies offer living death benefit features, which can provide policy owners with a terminal illness, chronic illness, and/or critical illness feature. This can work as a supplemental plan for long-term care insurance.
What Are The Drawbacks Of Indexed Universal Life Insurance?
While there are many benefits of owning an indexed universal life insurance policy, there are some important cons of indexed universal life insurance you should understand.
IUL policies do have a guaranteed floor, which prevents you from losing money if the index followed has a bad year. But there are expenses that you must cover when you own one of these policies. If the interest earnings from the indexing feature are less than the policy expenses of the life insurance policy, you will lose some of your cash-surrender value in the policy.
You do have to be careful about how much money you put into the policy. If you contribute too much, you could create a modified endowment contract (MEC).
IUL's do have surrender charges. This means that you will not be able to cancel your policy for several years without losing some of the cash value accumulated in your policy. Eventually the surrender charges do go away, but this can take more than 10 years to happen.
Lastly, the cost of insurance on an indexed universal life policy can increase each year. This rising cost of insurance could lead to problems for some policy owners who do not pay premiums in the amounts originally planned.
How To Get An Iul Policy
If after reading the above, you think that an indexed UL policy is right for you, you should begin seeking out help from a licensed insurance agent.
You should understand that not all insurance companies and not all insurance agents deal in indexed policies. So you'll have to find an agent who works with a company that sells IUL policies. Luckily, there are quite a few companies and agents you'll find to choose from.
The application process for an indexed universal life policy will be very similar to the process for all other types of life insurance–this includes whole life insurance and term life insurance.
How Much Does IUL Cost?
Indexed UL policies will have a cost very similar to whole life insurance. This means the policy will be considerably more expensive than term life insurance for the same death benefit, but IUL policies are intended to last for your entire life.
How Much Can I Contribute To a Policy
The amount that you can contribute to an indexed UL policy depends on your chosen death benefit amount and age at policy issue. Larger death benefits will allow for more contribution.
Your insurance agent can help guide you on the maximum amount that you can contribute to this policy.
Why Is Indexed Universal Life Insurance So Popular?
Indexed life insurance policies are popular because they give policyholders access to returns that are somewhat market-related without being subject to market volatility/risk of loss. This rate of return is theoretically higher than traditional whole life insurance and similar universal life policies that do not have an indexing feature.
Additionally, IUL policies provide several tax benefits that cause a lot of people to look at the cash value as having an almost Roth IRA like feature. This being said, a Roth IRA is a very different financial vehicle that should not be confused with life insurance.
Lastly, there are some people who use IUL and other forms of cash value life insurance as a tool to provide retirement income that reduces the taxability of social security income.
Should You Get Indexed Universal Life Insurance?
The decision to buy an indexed universal life policy depends on many factors. For someone who needs/wants death benefit and is looking for an additional way to accumulate wealth through insurance cash value, these policies might be a good fit.
Additionally, if you have a need for life insurance that extends beyond the coverage periods provided by term life insurance policies, you may find what you are looking for with an IUL.