As American savers become more conservative. There is more interest in saving for retirement in permanent life insurance policies. Permanent policies allow the policy owner to save money in safe tax-advantaged vehicles. The most popular options are indexed universal life and whole life. Which one is better? Let’s talk about IUL vs Whole Life.
Life insurance products like Whole Life insurance and Indexed Universal Life (IUL) have begun to establish a significant foothold in the marketplace even though there are as many naysayers as fans of these two products.
Although product selection depends on several factors that are personal to each consumer, there are features in each of these insurance products that we can evaluate and determine which one is more likely to deliver as a better savings vehicle.
Under the Hood of IUL and Whole Life Insurance
Whole Life Insurance Details
Whole Life insurance has been the cornerstone of the cash value insurance marketplace for at least a century. The product’s popularity appears to rise and fall with the attitude and opportunities that are prevailing in the market during various periods of time. Here’s how whole life insurance works for the policyholder:
- The investor (policyholder) purchases the policy by paying a premium to the insurance carrier.
- The annual premium must be sufficient to support the selected death benefit using two specific assumptions: the highest mortality and administrative charges and the lowest possible interest rate the insurer estimates it would pay in a worst-case scenario.
- On an annual basis, the company board of directors is charged with determining the actual experience and will adjust the initial premium using an annual dividend declaration. (This method is similar to intentionally overpaying your taxes and getting a refund once you’ve calculated your actual tax liability).
- The cash value in your policy then increases after the insurer credits the cash account with the interest and dividends.
Historically, whole life insurance was the preferred cash-value life insurance that most people used until consumers started to ask for various updates because the feeling was that the product was dated and needed a facelift. This new attitude forced the insurance market to re-examine traditional whole life insurance in the early 80s. Here’s what the carriers heard from consumers:
- They wanted more transparency.
- A distinctive separation between the death benefit component and the savings component
- More flexibility in the insurance product
These demands asserted by consumers triggered the development of Universal Life Insurance. To meet the demands in the marketplace, industry product managers and developers created an indexed form of Universal Life that they felt would expand consumers’ choices. Ultimately, this indexed version of the UL product was introduced in the late 90s.
Indexed Universal Details
Indexed Universal Life (IUL) insurance, although a little more complicated than whole life insurance because of the following differences:
- The annual premium for the IUL is established to support a selected death benefit (face amount). Typically, the annual premium is an overpayment (see the tax scenario above), which means that it is a premium that is higher than necessary to support the death benefit and administrative fees. This overpayment allows the cash value account to accumulate funds.
- The policyholder earns interest credits based on a formula linked to popular market indexes like the NASDAQ and S&P 500.
- The policy’s expense and mortality charges are calculated yearly and then charged against the cash value account.
- As regulation requires, the policy must specify the maximum expense and mortality charges and the minimum amount of interest it will be credited.
- Instead of establishing the interest and charges as part of the premium calculation and then crediting the difference at the end of the year, with the IUL product, these maximum and minimum rates are not charged upfront and then credited back but, rather, they are used as a barometer of what the insurer could potentially use if future experience requires changes in the policy premium.
The indexed universal life insurance policy is commonly used as a retirement planning vehicle. You may hear the IUL referred to as a LIRP (Life Insurance Retirement Plan), a 770 plan, or 7702 plan. All of these are just marketing nicknames that are used. At the end of the day, IUL is life insurance.
IUL vs. Whole Life Insurance
When we compare Indexed Universal Life to Whole Life insurance, we should consider the following five aspects that can have a significant impact on a customer’s experience and value for the long term:
- The Carrier’s Financial Stability – Since life insurance policies represent a long-term financial promise to the policyholder, consumers should elect to trust their investment with highly-rated insurance companies.
- Focus more on the Savings Component and Less on the Death Benefit – It’s important that your insurance policy is structured properly and meets your long-term savings needs with an appropriate death benefit. Overfunding a whole life policy can cause the policy to become a MEC and run afoul of the IRS. On the other hand, selecting a large death benefit for your IUL will gobble up substantial cash value and prevent your policy from meeting your financial goals. Whether you select IUL or Whole Life Insurance, it’s important to work with an experienced and reputable insurance professional so that your policy will be structured to meet your needs.
- Interest Crediting to the Cash Account – Interest crediting is typically considered the most important feature. This feature is what differentiates cash value life insurance from other investment products and allows a consumer to use IUL and/or Whole Life Insurance as a vehicle to supplement their retirement income.
How each policy earns interest and how it is credited creates a substantial difference between the two insurance products. While life insurance cash value is affected by the performance of the carrier’s investments, the IUL’s cash value is affected by the performance of the indexes linked to the cash account.
Expense and Mortality Charges – Certainly, for your IUL or Whole Life policy to accumulate sufficient cash value to meet your goals and needs, how much your policy earns over time is critical. With Whole Life, a premium is established sufficient to meet the maximum mortality and expense charges, like assuming the worst might happen. Then, the insurance company reduces the premium based on a favorable outcome of its investments instead of a worst-case scenario.
With an IUL, however, your premium isn’t based on the “worst case scenario,” but instead, it’s based on an assumption of charges that are below the “worst case scenario,” which allows more premium to go to growing the cash value in your policy. Then, the performance of the index accounts is credited to your account to impact the cash value further.
Flexibility – The insurance carriers have built flexibility into the IUL and Whole Life insurance products to accommodate unfavorable market assumptions. With the IUL, since the expense and mortality charges aren’t etched in stone, the company can elect to raise its fees if it needs to offset the difference. With a Whole Life policy, since the carrier does not guarantee dividends, the company can reduce the dividend payment or even not pay dividends to offset an unexpected increase in mortality rates and expense charges.
Deciding on IUL or Whole Life
Although you can accumulate significant savings over time with an IUL or Whole Life policy, each product type takes a different approach to delivering value to the policyholder. The IUL product offers value through indexed crediting based on certain stock market indexes, while the Whole Life product delivers significant value through dividends paid annually. We find that whole life insurance fits into the conservative financial portfolio. IUL is for the riskier portfolio, even though there is no risk of loss due to stock market declines.
An illustration comparison between IUL and whole life insurance is necessary to make that decision easier. As independent life insurance advisors, we can provide these illustrations.
Frequently Asked Questions
What's the best reason to choose an IUL over whole Life?
Interest crediting is typically considered the most important feature. This feature is what differentiates cash value life insurance from other investment products and the IUL generally accumulates weal at a faster pace than whole life insurance.
Hasn't whole life insurance always been the cornerstone for cash value growth?
Historically, whole life insurance was the preferred cash value life insurance that most people used until consumers started to ask for various updates because the feeling was that the product was dated and needed a facelift. This new attitude forced the insurance market to re-examine traditional whole life insurance in the early 8os and as a result, the IUL product was conceived.
Doesn't the IUL policy have higher fees than traditional retirement plans?
Since fees are charged based on the death benefit rather than account value like traditional retirement products, the costs of an IUL are actually the same as or even lower than fees charged for a 401(k) or IRA.