What is Indexed Universal Life?
Indexed Universal Life insurance works the same way as a regular universal life policy in that it provides a death benefit and a cash value. The main difference between them is the cash value component. In a regular universal life insurance policy, the cash values interest is based on a guaranteed interest rate declared each year on the anniversary date. The indexed universal life also has a guaranteed rate declared each year, but it also has a component that the interest is based on an underlying index, such as the S&P 500 or Nasdaq.
The index option that within an indexed universal life policy comes with some parameters. There is “cap” (most you can earn) on the interest credited. With that said there is also a “floor” or guaranteed minimum. You can’t lose!
To give you an example, if your index cap is 12%, and that index returns 14% that year. You would earn 12%. Let’s look at the flip side, if the next year that same index returns -8%, you would receive 0%.
These types of policies give you the upside of the market to a point without the risk that comes with investing in the market. It’s a win-win if planned and funded properly.
Here are the pros of Indexed Universal Life
- Higher Potential Earnings- Leveraging call options to gain upside exposure to equity indexes with the risk of loss allows these policies to earn higher interest without a chance of loss.
- Flexibility- These policies allow the owners to decide how much market risk they can handle. You can also reduce death benefit at anytime after the first year.
- Tax Free Gains- You will not pay any taxes on the interest you make each year.
- Tax Free Withdrawals- If withdrawn correctly the gains are also tax-free if the policy stays in-force.
- Annual Reset- Each year on your anniversary date your policy resets and any gains are locked in. The policy also resets the index even if that year was a loss. You never have to play catch-up.
- Protection- In some states, cash value in life insurance is protected from lawsuits and creditors, including bankruptcy.
Here are the cons of Indexed Universal Life
- Fees: All indexed universal life policies come with fees tied to the cash value element. Sometimes these fees can increase each year, so it’s important to investigate.
- Annual Renewable Term: Every year you get older the cost of insurance (COI) increases. The cash value accumulation is supposed to offset this, but if not funded properly this could be a big problem especially later in life.
My two cents
If you are looking for a permanent policy, then the indexed universal life policy is an excellent option. It will provide you with lifetime death protection to age 120.
Indexed universal life is also way to build up cash value without the risk of losing it like in the market. It can be withdrawn tax free to help supplement your retirement, take a trip, or buy that second house. Overall, I would recommend an indexed universal life policy. Always team up with an experienced agent who can help guide you through the process.