Indexed universal life insurance can be a good option if you want the adaptability of universal life insurance and the savings power of a cash value account. You can enjoy some of the benefits of the stock market with minimal exposure to loss by purchasing an indexed universal life insurance policy, or IUL.
An IUL policy is a long-term investment, so it’s essential to do your research. There are more ups and downs with IUL coverage than with other life insurance types because the cash value is tied to the stock market. However, indexed universal life insurance may be the best option for the discerning investor who also values policy flexibility.
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What Is Universal Life Insurance?
There are many kinds of universal life (UL) insurance, ranging from those with a fixed interest rate to those with a variable interest rate, that allows you to invest in various equity accounts. The policyholder of an IUL policy can invest the policy’s cash value in either a fixed or equity index account. A wide range of popular indexes, including the Nasdaq-100 and the S&P 500, are available through these policies.
While IUL policies are more prone to market fluctuations than fixed UL policies, they are safer than variable UL policies due to the absence of equity investments.
A death benefit is included in the policy, and premiums are paid tax-deferred so that money can be saved for retirement. IULs are a type of permanent life insurance that can be used for various purposes, including key person insurance for entrepreneurs, premium financing plans, and retirement planning, all while offering the added benefit of potential cash accumulation through an equity index. IULs are complex life insurance policies that require expert knowledge to understand.
Explaining Indexed Universal Life (IUL) Insurance
IUL, or indexed universal life insurance, is a subset of UL. The cash value component’s growth is linked to the performance of a market index, like the S&P 500, rather than a fixed interest rate.
On the other hand, you will not suffer losses in a market downturn, unlike if you invested directly in an index fund. This is because a guarantee protects your principal. However, the maximum return you can make is typically limited. Your policy’s value may be split between a fixed and an indexed component, which is often an option.
Knowing the basics of the different kinds of life insurance will help you make sense of IUL. Term life insurance and permanent life insurance are the two most common types. Whole life and universal life insurance are two of the most well-known subsets of the latter group.
Whole Life Insurance
There is no time limit on when your family can receive a payout, thanks to the permanent nature of this policy. In addition, a portion of your premium payments will be deposited into a savings account. Withdrawals will be made from that account when there is enough money to cover them. While you’re still alive, you can access the money in several ways.
Universal Life Insurance
It’s a permanent policy with a savings component. The ability to customize aspects like monthly payments and death benefits sets them apart. Your premiums could be offset by the interest you earn on the cash value as it grows.
Term life insurance
This type of insurance typically has a duration of 10–30 years. Due to the limited time of coverage, this plan is considered short-term. In the event of your untimely demise during the policy period, your beneficiaries will receive a death benefit that can be used to pay for final expenses and make up for lost income. It’s cheaper than most other forms of insurance.
Example of Universal Life Insurance (IUL)
Taking June as an example, if the index increased by 6% from the first to the last day of the month, that gain would be multiplied by the cash value. When interest accrues, it is added to the cash value. Gains in an index may be determined by adding all of the daily percentage increases over a given period, as with some policies, or by averaging the daily percentage increases, as is the case with others. The cash account earns no interest when the index declines instead of rises.
According to a predetermined percentage, the “participation rate,” the policy owner receives a share of the index’s gains. Insurance companies can charge anywhere from a quarter to more than a hundred percent for their services. Assuming a gain of 6%, a participation rate of 50%, and an existing cash value of $10,000, the cash value would increase by $300 (i.e., 6% x 50% x $10,000). Index interest is added to cash accumulations at regular intervals (once a year or every five years) under most IUL policies.
Advantages and Disadvantages of Indexed Universal Life (IUL) Insurance
Those looking for permanent life insurance with a cash component that earns interest and a death benefit may want to consider an IUL policy. The premiums for permanent life insurance are higher than those for term insurance, but the beneficiaries receive a death benefit regardless of when the policyholder passes away. Cash value policies offer the advantage of possible policy appreciation and the possibility of policy borrowing.
Advantages
1. Low price
Because the insured person takes on the risk, their premiums are inexpensive.
2. Accumulation of Cash Values
Taxes are not paid on the growth of the cash value. The policyholder’s out-of-pocket premium payments can be reduced or eliminated if there is enough cash value in the policy to cover them.
3. Flexibility
The policyholder can set the risk level in indexed accounts and modify the death benefits payouts as needed. Numerous riders, such as guaranteed death benefits and no-lapse provisions, are available on most IUL insurance policies.
4. Death compensation
This lifetime payment doesn’t need to go through probate and won’t cost you anything in income or death taxes.
5. Lower potential for harm
To mitigate risk, the policy is not invested directly in financial markets.
6. Simplified dispersal
Any policyholder, regardless of age, can withdraw their cash value from an IUL policy anytime.
7. Unrestricted financial support
The annual contribution to an IUL policy is not capped.
Disadvantages
1. Proportional accumulation limits
In some cases, insurance companies limit clients’ enrollment to less than 100 percent.
2 . The more significant the face value, the better.
When compared to standard UL insurance, the benefits of a smaller face value are minimal.
3. Using a stock market index as a basis
Interest on the cash value will not be added if the index falls. (For extended periods, some policies have a low guaranteed rate.) Investment vehicles’ success is typically measured against market indexes. To beat the index is a common objective for these investors. The point of index-linked universal life insurance (IUL) is to gain value as an index rises.
While the cash value of an IUL that is tied to a market index may grow at a modest rate of return, the policy’s primary function is as insurance, not as a savings or investment vehicle.
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Source: Investopedia, Smartasset