Indexed Universal Life Insurance (IUL) Explained
Quick Facts
Indexed universal life insurance is a form of permanent life insurance, meaning you will have it until you stop paying your premiums
An IUL policy allows for better flexibility and the chance to have better financial returns
Risk is higher compared to other universal life insurance policies
If you’re searching for life insurance, you may have noticed that you have a vast amount of choices. From temporary life insurance to more permanent coverage, it can be overwhelming to try and figure it out by yourself, especially if you’ve been looking into indexed universal life insurance.
Life insurance acts as a form of financial protection in the event of your death. There are a few different ways you can set up the payout, referred to as a death benefit. This is money that will go to your beneficiary, whether it be a loved one or business, at the time of your passing.
Death benefits can be a safe financial cushion because they’re not taxed, and the payout can be set up to be over a period of time or as a lump sum.
With an indexed universal life insurance policy, there is more at stake than just the death benefit. This type of policy also dips into investment opportunities. However, there are some downsides that you’ll want to consider.
What are the pros and cons of indexed universal life insurance?
Every kind of life insurance comes with unique benefits and drawbacks.
Below are the best qualities of an indexed universal life insurance policy:
Allows for higher returns
Access to your account tax-free
Offers flexible premiums
An annual reset so you’re not trying to constantly recover from losses
Meanwhile, the drawbacks of indexed universal life insurance include the following:
Increased cost as you age
A cap on your potential returns
Higher risk than with other types of life insurance
Higher premiums and fees
Different people will have different needs when it comes to life insurance, so you’ll have to evaluate indexed universal life insurance based on your own personal circumstances to make an informed decision.
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What do you need to know about indexed universal life insurance?
With an indexed universal life (IUL) insurance policy, your coverage is tied to what is known as a market index. Some examples would be the S&P 500, Nasdaq, or the Dow Jones Industrial Average.
Each of these indexes follows a piece of the financial market, which in turn is followed by investors, or an insurance company when it comes to an IUL.
In the case of you having an indexed universal life insurance policy, this means that your insurance company would choose which index your policy would follow.
When your insurance company chooses an index for your IUL, that part of the market will determine the rate of financial returns you’ll see on your policy. This is how insurance agents are able to invest your money while ensuring the amount you put into your policy remains safe.
There are also going to be a few factors that will determine how much you pay for your overall policy:
The insurance company you choose. Each insurance company will have different indexes that they choose, which is why you’ll want to ask where they’re investing your money.
Your age. The amount you pay for your premiums will increase the older you get. You can always offset this by reducing the amount of your death benefit.
Guaranteed rate of growth. This rate often varies by the insurance carrier and protects your investment in the event of a tanked market.
Since an IUL is an investment, there are a lot of moving parts that have to be considered.
Why would you choose an IUL?
There are many reasons why a person would choose an IUL policy, but it does boil down to individual needs. Investing is a great way to see a higher return on your money while limiting the risks associated with blindly choosing where to put your funds.
An IUL removes the guesswork because it’s your insurance provider that makes all the choices.
Plus you’re free to borrow from your IUL account, though you have to be careful of any interest that will accrue on the withdrawn funds. You will need to make sure you pay it back. Otherwise, the money won’t be provided as part of the death benefit.
What is the difference between a 401(k) and an IUL?
A 401(k) is probably a more commonly known plan that many people set up with their employers. It often comes with the perk of your employer matching what you put into it, though this is usually only up to a certain percentage.
However, there are limits to a 401(k) and what it can do for a person. A 401(k) doesn’t offer a death benefit, for example.
Indexed life insurance provides a few more ways in which it can be useful, including the death benefit and access to the cash within the policy. Keep in mind that there are natural drawbacks, including fees and potentially higher premiums than other life insurance policies.
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What are some differences between an IUL and other life insurance policies?
The question may arise, why would someone choose an IUL over any other life insurance policy? There are a few other types of life insurance available, which is why it’s important to be aware of your options. This way you end up with a policy that’s right for you, instead of one that could be overwhelming.
Term life insurance is often viewed as the easiest of life insurance policies to understand, and can be affordable for what it returns. A term life insurance policy is set up to last between 10 and 30 years and is used to pay any final expenses or debts associated with your death, which can protect your loved ones.
However, there are no additional benefits should you live outside the policy-specified time frame.
Whole life insurance, sometimes referred to as permanent life insurance, is the type of policy people get if they have outstanding assets and want to see lifelong cash growth.
There are other types of life insurance that you can purchase as well, such as flexible premium life insurance. Flexibility is often important to policyholders, especially since life can change at a moment’s notice.
The Benefits of Indexed Universal Life Insurance
There are a number of benefits that follow an IUL insurance policy aside from the chance to increase the amount of your final payout.
The following are just a few of the pros that come with IUL policies:
Tax-free capital gains. The amount of money that you make is going to be tax-free, and this includes any money that you withdraw from the IUL. However, be mindful that if payment stops on the coverage or you surrender your policy, the funds you’ve withdrawn may become taxable.
Guaranteed death benefit. Regardless of your health, your loved ones or business will be guaranteed a payout after your death. This doesn’t change even if you develop an illness after investing.
Flexibility. Many people enjoy the flexibility of having an invested policy without having many of the risks associated with the financial market. It’s considered a contained amount of risk, in addition to you being hands-off in terms of which index is chosen.
Access to funds. You’re able to pull from your IUL if you end up needing money. Often, this can be referred to as a “forced savings account” because it’s money you need to have set aside and shouldn’t touch unless absolutely necessary.
While there are many advantages to having an indexed universal life insurance policy, there are also a number of disadvantages that you’ll want to know about before making your choice.
The Risks of Indexed Universal Life Insurance
With investing, there are going to be a number of risks associated with many of the details.
IUL policies come with these risks:
Fees. There are going to be additional costs associated with an IUL.
Administrative fee — Active for the duration of the policy
Mortality charge — Covers the death benefit to your family or business
Surrender charge — The fee you would pay for effectively leaving your contract if you surrender your policy
Expense fees — The remaining charges associated with maintaining your policy, such as paying commissions to an agent
Capped returns. A cap is a limit on the return you can get on your money. The cap will vary depending on your insurance company, but it will always restrict the rate of return you’ll see with your policy.
No set return amount. Indexing your life insurance policy means you aren’t guaranteed a specific financial outcome. Premiums will vary and often your money will fluctuate greatly. You’ll need to be comfortable with inconstant funds.
Needs constant monitoring. With flexibility comes the need to constantly stay on top of your policy. Unlike other life insurance policies, you’ll want to stay up to date with the financial market.
There is also the fact that an IUL can be canceled if the policy owner stops paying for it. This is a particularly negative situation to be in because this means you could lose access to the funds you’ve already invested.
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Is an IUL worth the investment?
Investing in an indexed life insurance policy depends on the amount of risk you want to take. If you don’t feel as though you’ll be able to keep up with the long-term investments, high premium costs, and all the fees associated with an IUL policy, you may want to consider a more standard form of investment.
Sometimes keeping your life insurance separate from your investment opportunities can be for the best.
The Bottom Line
Ultimately, whether you choose an IUL or any other sort of life insurance policy, the bottom line is that you will want to feel secure in your choice.
Having life insurance means that your loved ones and chosen investments will be safe after you’re no longer around. Whether this means you want an IUL or any other form of life insurance is up to you.
This is why you should always try to compare coverage across the board, not just with different insurance companies, but with various types of policies as well. Comparison shopping can be a great way to find the type of life insurance policy you’ll feel most comfortable having.
Frequently Asked Questions
Is an IUL policy worth it?
While it may seem exciting to bundle both your life insurance and the opportunity to invest in the financial market, it becomes hard work with unpredictable outcomes. You have the chance to increase your gains, but there are few guarantees that come with an IUL policy.
Is an IUL policy better than a 401(k)?
There are many benefits that come with an IUL that a 401(k) doesn’t offer. Your IUL will come with a death benefit and the ability to borrow against an additional cash value that a 401(k) won’t supply. However, a 401(k) offers more from the investment side of things, with there generally being a matched contribution from your employer.
Can I use the money in my IUL?
You can use the funds in an IUL tax-free, as long as you’re only withdrawing up to the amount you’ve personally contributed.
What are the downsides of an IUL?
You don’t get to keep excess money if the market has been good, and you often end up having to pay higher premiums the older you get. An IUL will not include stock market dividends, meaning the money you’re earning is fairly limited.
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Rachael Brennan has been working in the insurance industry since 2006 when she began working as a licensed insurance representative for 21st Century Insurance, during which time she earned her Property and Casualty license in all 50 states.
After several years she expanded her insurance expertise, earning her license in Health and AD&D insurance as well. She has worked for small health in…
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Written by
Rachael Brennan
Licensed Insurance Agent
Benjamin Carr was a licensed insurance agent in Georgia and has two years’ experience in life, health, property and casualty coverage. He has worked with State Farm and other risk management firms. He is also a strategic writer and editor with a background in branding, marketing, and quality assurance. He has been in military newsrooms — literally on the frontline of journalism.
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Reviewed by
Benji Carr
Former Licensed Life Insurance Agent
