Indexed Universal Life Explained

Written by Rob Pinner

Indexed universal life insurance is a universal insurance that includes cash value and death benefits. It is called indexed because the cash value portion of the policy earns interest according to a market index, i.e. NASDAQ and S&P 500. It has ceiling and floor cap depending on the stipulations in the policy. It usually does not exceed 10% and floor cap does not go on the negative thus, it usually caps at 0% to protect policyholders from market declines. So, when the market is at its high rate, you can be earning as much as 10% of your cash value every annual if you hit the cap. IUL has the capacity to earn as much as your stock investments, and with the earnings you can either withdraw via tax free.

As an investment medium, it is very good as it brings two profitable opportunities to your investment, the cash value and the death benefit.  The potential of earning profit and utilizing these earnings while you are still alive provides extra leverage. But like any investment product, it has its drawback and fine points of criticism to match the benefits. Because it is indexed to a market rate, there’s an aspect of volatility that may result to paying higher premiums at the later part of the policy if the cash value does not earn or is depleted to pay for cost of insurance increase.

The Benefits of IUL

The benefits of index universal life insurance are obvious, earning an interest that’s higher than standard interest rates or other investment mediums such as bonds. The potential of doubling your savings via cash value while still alive and utilizing it to pay for college education, retirement income or going into business are too sweet to miss. Here are enumerated benefits of IUL that you should consider:

  • As stated earlier it has the potential to earn higher interest rate on the cash value because the rate is indexed to a market rate. Most insurance policies rates range from 8% to 12%. It usually does not exceed 15%. The interest rate is a derivative of the percentage change of an index for a given time frame – monthly, quarterly, semi-annually or annually. So if on an average, the index rises to 9% for a given period, the cash value earns 9% in interest.
  • Market fluctuations are the necessary evil of investment. Even though the cash value interest rate is based on a market index, it is shielded from any stock market decline or crashes through a floor rate. The floor rate protects the policy from the decline that’s lower than the stipulated lowest percentage, i.e. if the floor is 0%, and the index fluctuates and declines to -3% then the cash value earns 0% but not lower than this percentage.
  • Indexed universal life insurance offers different cash value withdrawal options. Once you’ve accumulated enough saving in your cash value, you have the option to withdraw via loans. You can loan against the death benefit or arrange to have periodic payments to replenish the cash value and secure the benefits after death kept intact. In order not to pay high premiums because you’ve withdrawn from the cash value account is to establish a payment schedule that will keep everything at the positive. This means the cash value earning should be greater than the interest of the loan and the principal.
  • If indexed rate is not you or you don’t feel secure enough with an indexed interest, you have the option of switching to a fixed rate. Some people do not like risk, so insurance carriers provide the switching to fixed percentage option to keep policyholders happy and if they feel this will be more advantageous in the long run.
  • Like most life insurance, indexed universal benefits and cash value withdrawals are not subject to tax. First of all, when you usually pay insurance after being taxed, it is a post tax expense. There’s no need to deduct from the money after taxation. So most insurance investments are tax free, including IUL.

Drawbacks of IUL

Indexed universal life insurance is a sweet deal in terms of earning potentials but there are certain drawbacks or disadvantages that you should also be aware of. Not everything about IUL is ideal for everybody and it is better to know about these drawbacks before taking the plunge and signing the dotted line on an IUL policy.

  • Expect a surrender charge when you withdraw from the policy for a certain period. The surrender charge clause actually discourages policyholders from withdrawing up to a certain period of time, i.e. 10 to 20 years. It is like a deferred sales charge that gives authority to the insurance company to charge or deduct a certain amount (depending on what’s stated in the policy) if the insurance is cancelled. Check the surrender charge rate before committing to the insurance.
  • There are certain requirements before a person can qualify for an indexed universal life insurance. If you do not pass the requirements including level of income, you may not be able to qualify for a policy.
  • Not all policies are created equal. Depending on the insurance carrier, the interest rates ceiling and floor rates may vary and may not earn as you intend it to. Check the cap and floor rate, if these are suitable for your investment scheme.
  • The insurance portion deducts more expense charges that will means less difference for your cash value. Insurance expenses may increase over time. This means the insurance cost will increase. And when this is deducted to your premium, it leaves less money to be added to your cash value. In some cases, the expenses becomes too high that it will eat up all your premium or you end up paying premiums with your cash value. Consider these incremental costs; talk with a financial advisor and insurance agent on the possibilities of increasing costs of keeping the insurance over time.

It cannot be reiterated enough how important it is to study carefully what insurance option you choose that will maximize your ability to save and keep your love ones protected. The indexed universal life insurance is a very good and profitable scheme if you know what you are getting into and can weigh the benefits and drawbacks optimally, so you get the best policy suited for your financial needs. A lot of people were able to leverage and profit from this kind of universal life insurance in terms of utilizing the cash value. Talk to an experienced agent about it and know your options.

Rob Pinner
Rob Pinner

I have been a licensed insurance agent for over 15 years.  If you have any questions or comments please don’t hesitate to give us a call.

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