Indexed Universal Life Insurance 101

A New Take on an Old Model

Indexed Universal Life Insurance 101
October 5, 2017

When it comes to life insurance, there are so many different options and "flavors" that deciding which type of policy is right for you can be difficult and confusing. Not to complicate matters even more, but there is one type of insurance that you might want to add to the flavor mix if you are shopping for life insurance: indexed universal life, or IUL.

IUL is a form of universal life (UL) insurance, which is itself a form of whole life insurance. Whole life insurance is also sometimes referred to as permanent insurance because it provides protection for as long at the insured lives, instead of just for a period of years, like term life insurance.

Cash Value and a Death Benefit

Policies under the whole life umbrella allow policyholders to build up cash value within the policy on a tax-deferred basis while still enjoying a death benefit. Accumulated cash value can be tapped for a variety of needs, including retirement income.

Depending on the type of whole life insurance, policyholders can invest their cash value in a variety of different vehicles via what are called subaccounts. Indexed universal life allows policyholders to invest their cash value in an equity index account, like the S&P 500, Russell 2000 and Nasdaq 100.

Indexed universal life insurance is similar to variable universal life insurance (VUL), with one key difference: VUL policyholders can invest their cash value in stock and bond subaccounts that are similar to mutual funds. Conversely, an IUL's cash value can only be invested in an index account. This tends to make IUL policies less volatile than VUL policies.

In addition, IUL typically offers a guaranteed minimum fixed interest rate over the long term, and the principal is generally protected from loss, which makes IUL less risky than VUL. At the same time, though, there may be a cap on the accumulation percentages of an IUL policy, which effectively limits the return potential. In other words, IUL generally features less risk than VUL, but also lower potential return.

How an IUL Policy Works

A portion of each IUL premium payment goes to pay for the insurance component of the policy, another portion goes to pay fees, and the rest goes to cash value. The amount of interest credited to the policy is calculated based on the difference in the value of the selected index at the beginning and end of the month, with gains credited to the policy on a monthly or annual basis.

For example, if the selected index gained 4 percent during the month of October, 4 percent of the current cash value would be added to the policy's total cash value. If the index goes down in October, no interest is added to the cash value — but no cash value is subtracted, either.

Note that the insurance company can set a percentage rate that effectively limits the amount of interest that can be credited to an IUL policy. This participation rate generally ranges from 25 percent to more than 100 percent. So if the selected index gained 4 percent in October, the cash value that month was $20,000 and the participation rate was 50 percent, then $400 would be added to the cash value [(.04 x 20,000) x .5 = $400].

IUL is just one of many different types of policies you should consider if you are shopping for life insurance. Given all the different life insurance options and their complexity, it is a good idea to talk to a financial planner and life insurance expert for help in choosing the right kind of policy for you and your family.

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Photo ©iStockphoto.com/Ildo Frazao

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Saving in WI | 10.05.17 @ 15:22
Whole life insurance is not the best option for investing. It is the worst option for investing. Buy term insurance and invest your money some place else. Financial planners do not recommend investing in whole life policies.
kirby | 10.05.17 @ 18:15
Often, I hear the terminology that is used to describe one type of life insurance or another type. It gets crossed up sometimes. Then, there is the word "investing" that also enters the fray. Truth be told, life insurance is technically considered to be income replacement, not an investment. Yes, I know that there is cash accumulation with permanent plans, but you can also get permanent plans that develop only enough cash to support the policy value - which means you don't take any cash out ever since it is not designed for that. Remember that life insurance, when it is permanent coverage, is a *death benefit* for the rest of one's life - that is the primary purpose. Investments are not a death benefit. Pretending that it is an "investment" so that one can compare it to other investments is faulty logic. I'll apply the same faulty logic right now: other investments such as stocks are bad because they don't have a fixed death benefit. See how I made it sound like investments are lacking or are bad because they don't behave like life insurance? That is the same as saying that permanent life insurance is bad because it does not behave like true investments. Everyone who needs a death benefit for the rest of their life may get it with permanent life insurance, and skip the investment nomenclature, since the goal may be just the death benefit. Example: Universal Life is permanent coverage, and is not "Whole Life" (yes, they are different in quite a few respects, and the same in others), but both will get you to age 100 or beyond if you are looking for life insurance that is not term. Want to invest? Yes? Then do it all day. Want permanent life insurance? Yes? Then do that for all the right reasons, too - all day. Term coverage fits some needs, but not all needs. One product does not answer the needs of millions of individuals with different circumstances, regardless of which product it is. Make sense?
$commenter.renderDisplayableName() | 10.16.17 @ 23:48
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