Indexed universal life insurance (IUL) is a life insurance policy that can be renewed annually for the full life of the policy-holder.
This insurance type may be lesser-known than other types of coverage such as auto insurance, but it’s no less important.
How Does IUL Work?
What makes IULs different is that only a portion of the premium is applied towards your life coverage.
The remainder, after fees, goes towards the cash value.
So, essentially, instead of just having straight life insurance, your policy also accrues value as time passes.
The interest that you earn is based on gains and losses in an equity index.
Premium holders often have a choice of how much to add to the cash value, and which indexes to track.
The index selected will be checked regularly from one month to the next or averaged out over a longer period.
Should the index increase in value, the gains are tracked, and the policyholder will get the benefit.
Let’s say, for example, that an index gained 3 percent in one calendar month.
The insurer will add 3 percent interest, or part thereof, to the cash portion of the policy.
Should the index lose value, however, then no interest is payable at all for that period.
The rate paid out is the participation rate based on the gains in the market, and how much you earn depends on your policy.
Some insurers pay out only a percentage of the gains as interest.
This could be anything from 25 percent and up. Some policies pay out over 100 percent.
Let’s use an example to illustrate this:
Say that you have $5,000 that has accumulated in your cash account.
The contract states that you’ll get 50 percent of whatever gains the tracked index makes.
If the index gains 10 percent, you’ll receive 5 percent interest.
If the index increases 5 percent, you’ll get 2.5 percent interest.
Interest is usually paid annually or every five years.
Is an IUL Worth It?
These policies work best for:
- Younger people in good health
- People looking to benefit through the deferred tax aspect
- Those who want access to stock market gains without risking their capital
Are they worth it?
That’s going to depend on your circumstances.
The life insurance costs will generally be lower than would otherwise be the case, and that could make it worthwhile on its own.
That said, the returns may not be guaranteed and may be lower than market gains.
If you only have a small amount of money for the cash accumulation, it may not be worth your while.
On the upside, if the market climbs, you could make significant gains.
On the other hand, if the market drops, you won’t receive any interest and would have been better off putting it into the bank.
We recommend investigating your options carefully before making a final decision.
Permanent Life Insurance vs. Term Life Insurance
Permanent life insurance covers you until the day that you die.
Term life insurance pays out upon your death, or when you reach a certain age.
Permanent insurance tends to be more expensive, so many opt instead for term insurance.
Term life insurance is not always the best alternative, though.
At least with permanent life insurance, you’re locking in the rate earlier.
The older you are when you take insurance, the more expensive it becomes.
With term life insurance, you would effectively be uninsured if you outlive the policy.
You’d receive a cash payout but taking new insurance afterward could prove expensive.
Rules of IUL Policies
One of the significant advantages here is that there is a lot of flexibility.
You could, for example, get a fixed-rate or variable option, and have a choice of equity accounts.
The cash portion is tax-deferred, and there are no limits to how much you can add to it.
The cash portion is not invested in equities, so you have some protection against the risk of the market taking a dive.
If you opt for a variable interest product, your gains will fluctuate with the market.
A fixed rate might be a slightly higher rate upfront and will not fluctuate.
How Much an IUL Costs
First and foremost, you need to realize that this is life insurance.
So, your primary premium will depend on your physical health.
You can usually opt to adjust the amount of the premium payable for the cash portion.
With the life insurance portion, however, your health and circumstances will determine how much you pay.
Life insurance becomes more expensive if:
- You’re a smoker
- Your health is poor
- You’re overweight
- You’re older
- You’re a man
We advise getting a few different quotes so that you get the very best deal.
Tips for Choosing an IUL
Use an Independent Broker
We’d advise speaking to a broker.
IULs are a more advanced insurance product, so you may need a broker’s expertise to make the right choices.
We’d also suggest that you choose an independent broker who can give you a range of options from different companies.
Does it Have Living Benefits?
Living benefits ensure that you have access to funds while still alive if you need them.
This benefit offers more than just being able to access the cash portion.
It also means being able to access some of the death benefits, which could be extremely valuable if you are diagnosed with a terminal illness, or if you become unable to work due to a disability.
Maximize Your Returns
With any investment, you want the maximum gain possible.
With an IUL, you get to enjoy the gains with minimal risk.
Look for a policy that guarantees your capital and market-linked returns.
Also, pay attention to how your participation rate is calculated.
While returns here might not be as good as what you’d get on the stock exchange, you are also not risking your capital.
So, that’s a win-win.
Check what the cap of the policy is as well.
When a policy is capped, your returns will be limited to the percentage listed as a cap.
Say, for example, that your cap is 25 percent and the market returns 40 percent.
You’ll receive 25 percent.
Consider the Underwriting Costs
An IUL is a pretty good investment vehicle, but it is not going to suit everyone.
You still need to weigh the costs of the underwriting when determining your premium.
The more expensive the underwriting is, the less of your premium will accrue to the cash account.
Say, for example, that you’re a man who is aged 65.
An IUL could work out expensive, and the potential returns would not be enough to offset these costs.
IULs work best for those who are healthy, young and want to diversify their portfolios.
That said, if the idea interests you, and you’ve got health issues, make an appointment to speak to a broker and get their advice.
Pros and Cons
- Costs are not as high as would otherwise be the case. In this instance, you’re taking risks as the participation rate is market-linked. Your interest rate is market-linked, so the insurer has less risk. The company can afford to give you a better deal as a result.
- The policy accrues cash value which increases the payout at a later date, and the balance can be left to grow. Should you be unable to continue with the premiums later, the cash value can be used so that your policy doesn’t lapse.
- It’s very flexible. You get to decide how much money is added to the cash value. You determine what portion of it pays for life insurance coverage. You are also able to choose which indexes to follow, so you can opt for higher risk/reward indexes if you prefer.
- There is a death benefit. This benefit is guaranteed and will not form part of your estate when you pass away. That means your family gets the whole lot without having to worry about paying death duties or probate fees on it.
- It’s a safer form of investment. Your money is not tied up in the stock market. You get to enjoy the gains, but you don’t have to worry about losing your funds.
- You have access to an early payout. You can access the cash benefit without an issue. So, if you need to have it paid out early, you can do so. You could also cede the policy when applying for a secured loan. The interest rate will be more favorable with a secured loan.
- You can contribute as much as you like. Unlike the standard IRA, there are no limits on how much you may contribute.
- The participation rates might be capped and might not be 100 percent of the gains in the market.
- It’s better suited to more substantial amounts. If your policy has a lower face value, it’s not going to perform much better than a standard universal life plan.
- It’s based on the equity gains, and few policies guarantee a minimum rate. So, if the market loses ground, you could end up with no interest being paid on the cash portion.