Indexed Universal Life Insurance
Indexed Universal Life Insurance (IUL) is considered to be one of the most versatile types of life insurance on the market. Its versatility is demonstrated by the number of financial situations it can be used for and the flexibility of the product in terms of changes that can be made by the policyholder to accommodate life events.
Most consumers have heard of Universal Life Insurance and Guaranteed Universal Life; Indexed Universal life is like both of these on steroids. IUL insurance is considered permanent insurance because it provides coverage for a lifetime but it is also used to create an asset that can earn significant interest based on market indices that a portion of the premium is invested in. The IUL also has a safety valve called a “floor” that guarantees the policyholder will not lose money if the market underperforms.
With Indexed Universal Life, a policyholder is able to resolve two very important financial needs:
- Purchase valuable life insurance to financially protect surviving loved ones and
- Create a solid investment plan that will produce income that is not subject to income tax.
How Indexed Universal Life Insurance Works
When an applicant sets up an IUL policy and a premium is established, part of the periodic premium the policyholder pays will be used to cover the cost of insurance (including fees) and then the remainder of the premium is deposited into a cash-value account.
The funds in the cash value account can then earn interest based on a portion of the index’s growth. It’s important to note that your cash is not directly invested into the indices. When the value of the index or indices goes up, your cash account is credited but if the index or indices does not increase or has a loss, your cash account will not be credited negative interest (you won’t lose money).
Every IUL policy has three very important controls or components that regulate how much your policy can earn and how your earnings will be protected:
The Participation Rate
The participation rate is like a piece of the earnings pie that your insurance company is willing to share with you. This rate can be as low as 25% and as high as 100% or more.
The CAP in your policy is the maximum amount of interest that your insurer is willing to pay into your cash account no matter how high the earnings are for the index or indices your cash account is linked to.
For example, if your policy with a 100% participation rate has a CAP of 10% and the earnings in your index or indices were 14% at the end of the index period, your cash account would be credited 10% based on your cap.
However, if your participation rate was 80%, the index earnings would be reduced by 20% which leaves 11.2% and then your cash account would be credited 10% of that amount (the cap rate).
Your IUL policy will also have a floor rate that determines the minimum amount of interest your cash account can earn at the end of each index period. This floor rate serves to protect your cash account during a volatile or down market so your account will not lose money. Most policies that we offer have a 0% floor rate and sometimes even higher.
For example, if at the end of the index period your index or indices have a 4% loss on earnings; your cash account would not lose money because the minimum interest rate would be 0%. This floor rate in your insurance policy is critical because it allows you to earn interest based on the market without actually being in the market and you will never suffer losses due to the poor performance of the market.
The Annual Reset
Another perk that is found in the Indexed Universal Life policy is called the annual reset. The annual reset is a lock-in that protects your index earnings so they will never be lost. Because of the annual reset, the interest your account earns this year is locked in and cannot be impacted by a volatile market next year. The annual reset provides for the current year’s ending index value to be the starting index value next year. Once again, you’re locked in.
How often will Interest be Credited to an IUL Policy?
The frequency in which interest is credited to your account will depends on the insurance company you choose to do business with. Many insurers use the “Annual Point-to-Point” method which means they credit interest earned on a yearly basis.
Other insurers may elect to credit interest more frequently such as every month, and others may choose to credit interest less frequently like every five years. Your insurance professional will walk you through all of the important details and each one will be part of the insurance contract.
How to Take Cash Out of an IUL
Over time your IUL’s cash account will accumulate significant funds that you can access your cash account via policy loans. Since these loans are considered “returned premium” they are not subject to income tax. You do not have to repay the loans either but there will be interest for the loan. Any unpaid loans will be deducted from the death benefit paid to your beneficiary when you die.
The cash value that builds in your IUL is yours to do with however you please and you are not constrained when you can access without penalties like other traditional investment products like a 401k or IRA. Many high-earning individuals face barriers set up by the IRS when they want to save for retirement. These barriers do not exist with an IUL policy. There is no limit on the amount of premium you can pay into your policy, there is no established age when you can withdraw your money without paying a penalty, and your account is not subject to required minimum distributions when you reach age 70 ½.
The Many Ways Indexed Universal Life can be Utilized
As we mentioned earlier, the IUL ‘s popularity can be attributed to the versatility and flexibility of the product. There many financial needs that an IUL can resolve:
Who should consider Indexed Universal Life Insurance?
IUL is a great policy that can accumulate wealth that can be used for many things. It’s important to understand, however, that for an IUL to be effective policyholders should consider this type of insurance and investment product to be a long-term commitment. If your preference is to purchase a large amount of life insurance for a short-term need, an IUL policy will not be the best solution.
To make an informed decision if an IUL is right for you, speak with an experienced and reputable independent insurance agent who will ask the right questions in order to provide the best advice.