How Does Indexed Universal Life Insurance Work?

"Successful people do what unsuccessful people are not willing to do.”


"Twenty years from now, you will be more disappointed by the things that you didn't do than by the ones you did do.”


"Sometimes later becomes never. Do it now.”

The Basics of indexed universal life insurance

Benefits

1. IULs offer a higher return potential.

One of the key benefits that is associated with an indexed universal life insurance policy is exposure to an equity index without the risk of loss. If the index suffers a loss during the policy period, the gain is simply 0%. On the other hand, a policy that has 100% participation that sees an index gain 11% would get to experience the full gain within the policy. Compared to other forms of life insurance, the returns tend to be higher over a long-term period.


2. IULs do not tax capital gains.

With an indexed universal life insurance policy, plan holders do not pay a capital gains tax on the increase in cash value they experience with it. The only exception to this advantage is if the policyholder decides to abandon their IUL before it reaches maturity. After maturity, even if a withdrawal occurs, the capital gains tax does not apply under current taxation codes within the United States.


3. There are usually lower premium rates.

Because there aren’t guaranteed interest rates and other growth factors involved, an IUL typically has a lower premium compared to other forms of life insurance which provide similar benefits. At the same time, because cash value doesn’t decrease should a target index fall, the only real threat to an indexed universal life insurance policy is inflation. The premiums are variable, based on the riders and needs of the policyholder, so some rates may be higher, but that flexibility is still an advantage.


 4. Some carriers will offer a guaranteed interest rate.

Although a 0% return is often an option for IULs when an index experiences a loss instead of a gain, some carriers have started to offer a guaranteed return. This buffer helps to offset the downside and is often paid for by the caps in place from the years there was a high upside. Because of this structure, some IULs function closer to whole life insurance products while still offering the benefits of the indexed structure.

 

5. Policy loans are usually permitted with IULs.

Most indexed universal life insurance plans allow for policy loans that are usually free of income taxes and do not require repayment. If the policy is surrendered, however, the loan becomes subject to income taxes on the tax year that the policy lapsed.


image46

Limitations

1. They are designed for a specific demographic.

Most indexed universal life insurance policies are not usually a good choice for someone with low-to-moderate income levels. The demographic which benefits the most from this type of insurance product are those with high wealth levels, high income earners, and those who own businesses and extremely advantageous for those person who are ultra-rich, young and healthy.


2. Most IULs do not count dividends.

The returns that are tracked by the index with an indexed universal life insurance policy only tracks the change in value that is experienced. The dividends that are earned by the stocks in the index are not usually counted in that valuation. Historically, dividends account for 20% of the market returns that are experienced on any given year. That means the index might go up 12%, but only 10% may be credited because of a 2% dividend. At a 50% participation rate, the final credit might only be 5% to the policyholder.


3. Many indexes have a 50/50 shot at over-performing their cap.

Many IULs are indexed to the S&P 500. Between 1928-2014, this index had a return above 12% 44 times, or more than half of the time. Now imagine if the IUL is capped at 10%. Even at full participation rates, the full benefit of the market gains will not be realized. Assuming a 12% cap, between the years of 1999-2014, someone with an indexed universal life insurance policy would lose 69% of the funds that an IUL holder with no cap on their policy would get to experience.

image47