At IBUSA, our expertise lies in helping people find the right life insurance coverage quickly and easily, including indexed universal life (IUL) insurance. The good news is that with many insurance companies adopting no-exam policies, it’s possible to qualify for an IUL policy without needing to take an exam, which can be a relief for those who prefer to avoid invasive medical procedures. By using accelerated underwriting, companies can do away with blood work and fluid samples, which can speed up the application process.
That said, it’s important to take a closer look at IUL insurance and weigh the pros and cons of this type of coverage.
Indexed Universal Life Insurance
Indexed Universal Life Insurance, or IUL, is a type of life insurance that’s gaining popularity because of its flexibility and growth potential. As a form of permanent life insurance, IUL policies remain in place for the rest of the insured person’s life, provided that they keep up with the premium payments.
This sets IUL apart from term life policies, which only provide coverage for a set term, such as 10, 20, or 30 years. With permanent life insurance, you can have peace of mind knowing that your policy will pay out whenever you pass away, regardless of when that occurs.
IUL Cash Value
In addition to providing lifelong coverage, permanent life insurance has a core characteristic of a cash value feature, which enables the policy to function as both a life insurance and a savings vehicle. With each premium payment, a portion is allocated towards the insurer’s underwriting costs, while the remaining amount is added to a cash-value account, resulting in an increase in the cash value over time.
As the policy remains in place for a longer period, the cash value grows even more. In some cases, if the policy remains in place long enough, the cash value can equal or even exceed the original death benefit or the policy’s face value.
Borrowing Against Cash Value
Permanent life insurance policies offer a progressively increasing cash value that can be utilized in different ways. Policyholders can borrow against it, withdraw it in whole or in part, or apply it to premiums later on.
Once a policy has accrued enough value to cover premium payments, it becomes paid-up, and no further payments are required. In the event that you no longer need the policy, you can surrender it, forgoing the death benefit, and receive a check for the policy’s cash surrender value.
Importantly, the cash value in a permanent life insurance policy grows in a compound interest account. The way in which cash value grows is what sets different types of permanent life insurance apart. In an IUL policy, the cash value growth potential is enhanced by the policy’s underlying index-based investments.
Types of Permanent Life Insurance
Whole life insurance is the most fundamental type of permanent life insurance.
With dividend-paying whole life, the cash value grows at a guaranteed rate, typically comparable to or higher than the highest-yielding certificate of deposit, and is supplemented by dividends from the insurance company.
Together with fixed premiums, the guaranteed growth makes traditional whole life insurance reliable, safe, and predictable, with no risk of loss.
While whole life insurance has been around for a long time, some policyholders are willing to accept some risk in exchange for potentially higher returns.
One example of a type of permanent life insurance that offers greater growth potential but with some risk is variable life insurance. With variable life insurance, you can invest the cash value of the policy in sub-accounts that are linked to the policy. These sub-accounts function similarly to mutual funds and their value can increase or decrease based on market performance. This means that variable life insurance has a higher potential for growth, but it also comes with the risk of losing money if the markets turn sour. In such cases, higher premium payments may be necessary to maintain the same level of coverage. If you plan to use a variable life insurance policy as a source of retirement income, a market downturn can be a significant financial setback.
IUL Blends the Two
Indexed Universal Life insurance is a hybrid between the security of whole life and the growth potential of variable insurance policies.
With an IUL insurance policy, the cash value is linked to an equity index, such as the S&P 500, so that policy growth corresponds to index performance. However, indexed policies come with mitigated risk or a no-loss guarantee from the insurance company. In other words, if the index goes down, the insurer will absorb some or all of the loss, and the policy won’t lose money.
Some IUL insurance policies even guarantee a minimum rate of return, regardless of index performance. This makes IUL policies attractive to those who want the potential for greater returns than traditional whole life insurance, but who are also risk-averse and want to avoid the possibility of losing money.
How Indexed Universal Life Insurance Works
Similar to other types of permanent life insurance policies, premium payments for an IUL policy are allocated towards underwriting costs and cash value. The cash value is then divided by the policyholder between a fixed account that grows at a guaranteed rate and an indexed account that grows based on index performance. This allows policyholders to tailor the policy to their desired risk level.
Younger policyholders who are more focused on long-term growth often allocate more towards the indexed account, while policyholders nearing retirement age may prefer to hold a greater portion of cash value in the fixed account.
IUL Insurance Companies
It’s important to note that IUL insurance policies can vary significantly among insurance companies and policies themselves.
Some insurers provide options to select between different indexes or to split the investment into various indexes. Additionally, some insurers may use a particular index.
It’s worth mentioning that the money in an IUL insurance policy is not directly invested in securities. Instead, the insurance company pays interest on the account based on the relevant index, often without considering dividends.
Calculations for IUL policies are based on index performance over defined periods, typically monthly, quarterly, or yearly. Daily market fluctuations are not relevant. Instead, the critical factor is the net change over the entire perio
Insurers can offset losses when an index goes down by sharing rewards when markets are up. There are various ways to set up an IUL insurance policy to achieve this.
The participation rate is the percentage of index gains credited as interest on a policy. For instance, if a policy has a 50% participation rate, interest is calculated as half of the index growth. If the policy has a $100,000 cash value, and the index increases by 10% over the interval, the interest paid would be $5,000 (or half of the 10% growth).
Participation rates can vary widely between policies, and some companies offer 100% participation or more and compensate for potential losses through other mechanisms.
Another approach is to cap the interest rate at an agreed-upon rate. For instance, a policy with a 6% cap will credit the index’s gains to the policy up to a maximum of 6%. If the index increases by 6%, the policy will receive the full 6%, but if it goes up by 8%, the interest will still be calculated at 6%.
A single policy can combine a participation rate and a cap to allow the policyholder some of the benefits of a bull market while still providing the insurer with a cushion when a drop inevitably occurs.
For example, an IUL policy can be set up to allow 100% participation up to 5%, and then 50% participation for gains above 5%.
Caps and participation rates are essentially the cost of eliminating downside risk. With that in mind, insurance companies often offer IUL policies with higher caps and participation rates if the policyholder is willing to accept a lower floor, which is the guaranteed minimum policy performance.
For example, a policy with a guaranteed floor of 2% growth will probably have a lower cap than a policy with a zero-loss floor. Similarly, a policyholder willing to tolerate a potential loss of up to 2% will likely be rewarded with a higher cap and/or participation rate as compensation for sharing some of the insurance company’s risk.
Floors and caps are the chief factors that determine an IUL policy’s predictability and growth potential. A policy with a 2% floor and a 6% cap is a stable, secure asset that provides protection against market downturns while offering genuine upside in good economic periods. This policy also comes with the peace of mind that comes with the death benefit.
Conversely, a policy with a negative 2% floor and a 12% cap involves some exposure to risk but also allows for excellent earnings in boom times.
The “right” policy for a particular person depends on various criteria, including age, other assets, the purpose of the coverage, and individual risk-tolerance preferences.
Other Features of IUL Policies
IUL policies offer some flexibility when it comes to premium payments, within a given range. Policyholders can choose to pay increased premiums for a larger cash value or death benefit. Alternatively, they can opt for lower premiums and sacrifice some of the policy’s value.
Sometimes, a policyholder may want to pay less in premiums when they need extra cash on hand, and make up the difference with future payments. If markets are performing well, they may even apply some of the growth towards premiums to maintain current liquidity.
It’s important to note that the amount of premium paid will directly affect the policy’s performance. As with most things in life, you get out of it what you put into it. But the flexibility of an IUL policy’s premiums allows you to adapt the policy to fit your overall financial strategy as your situation changes.
In addition to premium flexibility, IUL policies also offer variability in the amount of the policy’s death benefit. While the face value of the policy must remain within certain limits, you can adjust the percentage of the premium that is applied toward the death benefit versus the cash value. This allows you to modify coverage and growth opportunities to fit your current needs and circumstances.
For example, younger and healthier insureds can usually credit a higher percentage of their premium toward cash value, since the insurer incurs lower underwriting costs in providing the death benefit. This can help maximize growth potential for long-term financial planning.
The disadvantage of IUL flexibility is that, to be customizable, policies must also have a certain level of complexity.
The various investment options and formulas for calculating growth are notably more complicated than a traditional whole life policy with fixed premiums and interest.
Financially sophisticated policyholders who enjoy following investments are well-suited to IUL, but a policyholder who just wants to pay premiums and let the policy take care of itself might be better off with whole life, which is why proponents of infinite banking trend to steer practitioners towards whole life.
IUL policies also tend to have higher fees than whole life due to the more complicated investment structure.
Like most other types of life insurance, IUL policies offer multiple riders, which generally come at an additional cost. However, in many cases, the extra cost is worth it. Among the most popular IUL riders are living benefits riders, which accelerate death benefits in the event of a catastrophe that does not result in death.
Many insurers also offer riders covering terminal, critical, or chronic illnesses, or chronic injuries, with the benefit paid based on the severity of the illness or injury.
Living benefits riders allow an IUL policy to serve as a safety net in the event of long-term incapacity while still providing death benefits and a savings component.
IUL in Retirement and Estate Planning
IUL policies are useful as security in the event of early death, and also as a tool for life insurance retirement planning and estate planning.
The growth earned by the policy is tax-deferred until actually withdrawn, and there’s no tax penalty for early withdrawals like with an IRA.
If triggered, the death benefit is not taxable income to the beneficiary.
And an IUL policy owned by a life insurance trust can be an effective means of limiting estate taxes, providing for the care of loved ones, and ensuring that adequate liquidity is available to pay for administration and taxes.
Because indexed universal life insurance policies are a sophisticated and highly customizable financial product, it is usually wise to work with a broker or financial planning expert who has experience with IUL policies when looking for coverage.
An experienced professional can guide you through the application process and help you choose the appropriate coverage levels, investment options, and riders that best suit your needs.
It’s better to seek assistance early on to find the perfect fit for your situation and objectives, rather than limit your options and end up with a policy that isn’t ideal.
So don’t hesitate! Contact us today for a complimentary strategy session to determine if Indexed Universal Life Insurance is the right product for you, based on your specific needs, goals, and objectives.