Indexed universal life insurance is a type of permanent life insurance that pays interest based on the movements of the external index's from the beginning of a policy period to the end of the policy period ( 1 year or as long as 3 years) It's a subset of universal life insurance, which means policyholders can change payments and benefits as needed.
The cash accounts tied to an indexed universal life policy can grow quickly, but they can also see years without any growth. Other accounts offer trigger guarantees of 6% or interest accounts of 4%. Eventually, you may even grow the account to the point you can stop making premium payments. For many these can be designed to provide free-of-tax loans which do not need to be paid back and can be used successfully in supplementing retirement income Additionally if designed and managed correctly, a death benefit can be provided to the beneficiary tax-free in most cases.
Like other forms of permanent life insurance, indexed universal life offers a death benefit and a cash account. The death benefit is determined at the beginning of the policy but can change. Some policy owners can choose to have an increasing death benefit that grows based on the growth in eternal index accounts. The cash account grows based on the performance of modern index accounts designed to provide growth in good economic periods and to lose no money in poor economic periods ( fixed-principle assets protect principle).
A stock index, such as the S&P 500 or Dow Jones Industrial Average, is a way to track a group of stocks. Insurance companies pick one or more of these and pay interest to policyholders based on the index's performance - as value goes up, the account earns interest. If the index drops, the account earns less or nothing. Again, other accounts pay fixed interest and is not based on an index.
Cash accounts are first funded through premium payments. After the cost of insurance (covering your death benefit), rider charges, and other fees come out, the rest is added to your cash account. If you ever decide to skip a payment or underpay, those fees can be taken directly from the account.
The amount you can earn is subject to "floors" and "caps" to help minimize large swings in interest payments. The floor is the lowest your account rate can go and is usually guaranteed for the life of the policy but is often set at 0%. Other floors can be at 2% in some index accounts.
Caps are the highest interest rate the account can earn, so if the market is up more than the cap, you'll get credited only for the cap amount. Unlike the floor, your insurer can change the maximum rate while the policy is in force. As an example, let's look at an IUL policy based on the S&P 500 with a floor of 0% and a cap of 9.5%. Money that went into the cash account earns interest at the credited rate shown in the last column. Some index accounts offer uncapped or high par rates of 90% of the index growth or as high as 100% or more of the index growth. Some index's can even offer high partipation rates of 140% or more for a 1% charge on the growth. Trigger Accounts can pay a guaranteed rate. For Example, if and S and P Trigger Index offers 6% annual interest, that particular index only has to up .01% in that policy year to have the policy pay 6% of the balance of that account.
Indexed universal life insurance offers flexibility and could give you higher interest rates than other kinds of life insurance.
The major benefits of IUL are:
- Control over your death benefit and payments. You can increase or decrease payments, depending on your need for coverage, the growth of your cash account, and your financial situation.
- External Index-driven rates of return on your cash-value account. These accounts build up when the market grows and that growth is often accumulated tax-free. Since the market can outperform interest rates in other types of policy accounts, IUL policyholders have the potential to increase account values faster.
- Supplemental Income can be drawn from loans see IRS code7702.
- Death Benefits are provided to designated beneficiaries free-of-tax in most cases.
If you've decided IUL is the right policy for you, there are a few things to know before talking to a life insurance agent.
The first and most important is to understand how indexed universal life is sold. When you sit down to discuss options with an agent, you'll be shown an illustration. These are projections of the policy's cash value growth, based on conservatively-predicted interest rates, fees, payments and loans. These are helpful forecasts only, as actual results will play out differently from year to year. Still, illustrations are a helpful comparison each year to measure goals of the client. Agent advisors use illustrations when having annual reviews with clients, and adjust index options to enhance potential for best policy performance.
Your policy may have caps that come down over time, fees that increase or decrease, periods of poor market performance that aren't shown in the illustration. That is why illustrations are conservatively designed so that agent advisors do not over promise returns.
When considering an indexed universal life policy, make sure to check how slightly lower interest rates, higher fees or smaller premium payments could affect your results. Once you purchase a policy, remember to have annual reviews with your Agent for best results.