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The Pros and Cons of Indexed Universal Life Insurance (IUL)

Life insurance is an important purchase and one not to be taken lightly. There are many different types on the market, each with benefits and drawbacks. One example is an indexed universal life insurance policy, which allows you to grow cash value as part of your life insurance plan. So below we’ll look more in-depth at what this type of policy is and if it’s right for you.  

What is Indexed Universal Life Insurance?

Simply put, this is a type of insurance that provides potential cash value accumulation. Basically, the money you pay into the plan can grow in a market-linked manner. So when one or more market indices grow, so does the amount of money you paid into your policy. However, growth can be subject to floors and caps, giving the growth value a measure of stability. 

Indexed universal life insurance is a type of permanent life insurance, so there is no need to renew it. 

This is different from a fixed account, where you pay a premium to the policy and that amount earns a specific interest. In an indexed account, you get interest based on positive performance of a certain market index. Most insurance companies base the interest rates of their indexed universal life insurance (or IUL) product on the S&P 500 index.

Basically, an indexed universal life insurance policy allows you to benefit from the stock market without the financial risk of investing in the stock market. Unlike a variable universal life insurance policy, you are not undertaking the risk of directly investing in stocks and bonds.

>>MORE: Should I Invest in S&P 500 Index Through an Indexed Universal Life Insurance Policy?

>>MORE: Understanding Indexed Universal Life Insurance – Is It Good for Retirement Planning?

Ed Slott – a renowned tax expert – on tax benefits of IUL policies

Compare quotes of 30+ IUL products

Common Product Features of Indexed Universal Life Insurance

According to insurer North American, a common feature of these policies is that you can have access to the cash value through withdrawals and policy loans, such as net zero-cost loans. Often, you will have to wait a certain period of time before withdrawing. 

You may also be able to access part of your death benefit to help cover the cost of illnesses. These funds can usually be accessed tax-free. 

With indexed universal life insurance, you can skip premium payments for some time if money is tight as long as the cash value account in the policy is enough to cover the pure cost of insurance and administration fees and expenses charged by the insurance companies. The policy is designed to automatically withdraw money from the cash value account to pay for the pure cost of insurance and fees and expenses to keep the policy in force.

Cash value account in the indexed universal life insurance policy can also be used as collateral for a loan, a process known as collateral assignment of life insurance.

If you decide to cancel your indexed universal life insurance policy, you will receive the cash surrender value after paying surrender charge. Cash surrender value is approximately equal cash value account.

>>MORE: Case Studies of Universal Life Insurance

Indexed Universal Life Insurance Riders

This type of insurance product also has many different riders you can elect to attach. A few examples of the common ones you might see include:

  • Accidental Death Benefit Rider: Additional death benefit if death is from an accident. Learn more about accidental death life insurance.
  • Accelerated Death Benefit Rider: Makes death benefit funds available if the insured has a terminal illness
  • Children’s Term Insurance Rider: Extends term insurance to children up to a certain age. Learn more about life insurance for children.
  • Chronic Illness Accelerated Benefit Rider: You can get a portion of the death benefit if the insured has a chronic illness

You might also see riders to support small business needs.

  • Return of Premium Term Insurance Rider: Added death benefit that equals premiums paid
  • Supplemental Exchange Rider: Replace a covered employee with another employee

These are just some examples of many different types of riders you might see attached to an indexed universal life insurance policy. Be sure to discuss in-depth with an agent what your options for riders are with individual companies.

>>MORE: Indexed Universal Life Insurance vs. 401k

Pros and Cons of Indexed Universal Life Insurance 

An easy way to decide if this policy is right for you is to look at the pros and cons.

Pros:  

  • If you like a life insurance policy that maximizes both the coverage amount and retirement income through cash value growth, Indexed Universal Life Insurance is the right one for you. It is arguably the best retirement planning product.
  • If you are not a savvy investor but want to benefit from stock market performance, Indexed Universal Life insurance is a great option for you.
  • Floors often go down to 0 or 1 percent interest, meaning you’re protected against loss
  • Flexible premiums and death benefits
  • Withdrawal or loans from the cash value account, as well as death benefits paid to the beneficiaries, are tax-free. Learn more about life insurance proceeds are not taxable.

Ed Slott – a renowned tax expert – on tax benefits of IUL policies

Compare quotes of 30+ IUL products

Cons:

  • You’ll most likely have to make payments beyond the cost of insurance, which then gets put into accounts to grow with interest 
  • Less added benefit if markets perform poorly

>>MORE: Compare Whole Life Insurance with Indexed Universal Life Insurance

Whom is Indexed Universal Life Insurance For? 

Indexed life insurance is for anyone who wants the benefits of a traditional life insurance policy, but also wants the ability to grow cash value and withdraw from the account while still living. 

Often, these policies can be used for other purposes, like diversifying a retirement portfolio or growing a college fund, according to Mutual of Omaha. As such, sometimes indexed universal life insurance policy is considered similar to a 401k account. However, they do have their unique differences.      

Withdrawals from the cash value account of indexed universal life insurance are income tax free. This is the reason why more and more people have life insurance in their retirement plan. Learn how to use life insurance in retirement planning through a case study.

How Much Does Indexed Universal Life Insurance Cost? 

Life insurance costs vary by individuals since its costs depend on health conditions of the insureds. Each person should expect to have his or her unique prices.

We have an illustration of a plan for a 45-year-old man. For a base death benefit/coverage amount of $150,000, he pays a monthly premium of $210. Bear in mind that this is an illustration, which usually reflects the market condition of the past 40 years. The market condition might be very different in the next 40 years.

By the time the insured is 70 years old, the policy has a cash value of $94,147. If he lives to 90 years old and keeps the policy active, the policy has a cash value of $325,416.  

An interesting note on this mock policy is that for the first couple years of the policy, the man does not have access to the cash value. By the third year, he has access to $1,753. By age 70, the amount goes up to $94,147, the same as the total cash value.  

Meanwhile, the death benefit goes up to $244,147 by age 70, up from the base death benefit of about $150,000 when he started the policy at age 45. So you can see how the plan accumulates cash value and additional death benefits over time.  

Final Thoughts

Indexed universal life insurance provides you with the death benefit of a traditional policy, but also allows you to grow cash value based on market index performance and pull money from the plan while alive. This is a solid plan option for those who want a high degree of growth and flexibility from their life insurance plan.

Ed Slott – a renowned tax expert – on tax benefits of IUL policies

Compare quotes of 30+ IUL products

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