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Indexed Universal Life (IUL) Explained

Indexed Universal Life (Updated for 2021)

First offered in 1997 by Transamerica, IUL has seen tremendous growth over the last 24 years. Today there are more than 40 companies offering these types of policies and more joining the mix each year.

Here’s a brief video explanation:

YouTube video

IUL offers permanent life insurance protection with the opportunity to earn market-like returns inside the policy.

You can access this growth at any time during the length of the policy on a tax-deferred and tax-favored basis.

Very similar to a Roth IRA, the cash value of an IUL grows tax-deferred and income can be tax-free.

How Popular Are IUL Policies?

According to the Life Insurance Marketing and Research Association (LIMRA), this category of life insurance has been continually growing in popularity for many years now.

In fact, Indexed UL was the fastest-growing product of the individual life insurance market in 2021, more than 20% of all new premiums were IUL policies..

Many IUL policy holders say they chose to purchase not only for the death benefit but also as a way to grow their investment portfolio

When structured properly as an accumulation vehicle, you would want to pay the maximum premium possible while keeping the death benefit to a minimum. This keeps your policy expenses lower and more premium available to accumulate interest.

The difference between IUL and other permanent life insurance policies is the way interest is credited to the policy. Interest is linked to the movement of a selected stock market index over a specific period of time, usually 1 year, but some policies offer 2 and 5 year periods.

Even if the index goes down, your credited interest rate will never be negative and that is guaranteed. So your worst-case return for a year could be 0%.

For example, let’s assume you choose the S&P 500 index with a 9% cap within your policy. The day your premium is paid, we’ll use January 1, the S&P is trading at 4000. The insurance company tracks the S&P index from January 1 through December 31.

Whatever the S&P index is trading at on December 31 is the ending value in which your index credit is calculated. If the S&P index is trading below 4000 then the policy will receive 0% interest for that policy year. However, let’s assume that on December 31, the S&P is trading at 4400.

That is a 10% increase in the S&P index and because of the cap, your policy would receive an interest credit of 9%. That sounds great but also keep in mind that there is a feature called the annual reset. This makes a great design even better.

IUL Annual Reset

Annual reset means that each year’s interest credits are locked in on the Index Crediting Date and a new starting point is determined.

The interest credits can’t be taken away due to negative index performance. They will participate in future growth, giving your policy the advantage of compounding interest in future years.

In the example above let’s assume that the S&P index is trading at 3600 on December 31. That is 400 points lower than where we started on January 1. Instead of losing 10% from your account you lose 0% and your new starting value on January 1 is now 3600.

This is the beauty of the annual reset. You do not have to wait until the S&P value is above 4000 to share in any gains. Now in one year, on December 31, the value of the S&P is measured and interest credits are calculated again.

This protection from loss is a great way to keep peace of mind while also growing your assets. The protection that IUL offers from negative return years is a key reason IULs are so popular.

IUL Caps Explained

The gain in an IUL policy is determined by the allocation that the policyowner selects. These allocations can be as common as the S&P 500, Dow Jones and NASDAQ. Today we see these caps in the 9% range.

As recently as 4 years ago, caps were readily available in the 15% range. The reason caps have lowered is that the cost to participate in the main 3 indexes has increased.

New allocation options are coming out all the time by companies offering IUL policies. The new allocations are proprietary to the companies and cut down on expenses. This allows for higher caps and better possible returns. Three of the newer options are:

  • Fidelity Multifactor Yield Index (North American)
  • Bloomberg US Dynamic Balance II ER (Allianz)
  • PIMCO Tactical Balanced ER Index (Allianz)

With the proprietary allocations, companies can offer higher caps because they are managing these indexes in-house. Some are even un-capped!

A good example is if you had an Allianz policy and chose the Bloomberg US Dynamic Balanced Index, you would have no cap and 140% participation rate. If the Bloomberg index grows 10%, you would see a gain of 14%.

Quick IUL Facts

  • Interest is credited to the policy’s index account value based on the performance of the index chosen and will never be less than zero percent.
  • Premiums are not directly invested in any stocks, bonds, or equity investments.
  • Index performance does not include dividends on the stocks that make up each index.

Ways To Access IUL Cash Value

You may access your cash value through withdrawals or loans.

Withdrawals – when you take a withdrawal from your policy, you will permanently reduce its cash value. The withdrawal will generally be income-tax free up to the amount of premiums that you have paid into the policy. You may also face surrender charges on the amount that you withdraw.

Loans – taking loans can be a huge advantage to accessing your cash value and they don’t even need to be repaid. Like taking a home equity loan against your house – loans from you IUL cash value are not taxable. There are generally 2 types of loans; standard and variable loans. The most commonly used is the variable loan.

IUL Overloan Protection

One very important feature in some IULs is the Overloan Protection benefit.. Your policy death benefit remains in force when extensive loans have been taken if the overloan protection benefit has been elected.

This benefit may help you avoid tax consequences of a policy lapse due to excessive loans or withdrawals. This is very useful if you plan to use your policy as an income supplement vehicle.

IUL Premiums Are Flexible

The Indexed Universal life insurance policy premium is flexible. This means that the insured can increase or decrease the premium to the policy as finances change. They may even stop paying premiums for a while if needed. But remember, the more premium paid into the policy the better the performance.

Indexed Universal Life insurance is often called living insurance.

What about IUL Living Benefits?

A unique feature of IUL is that it includes living benefits. Living benefits are for chronic illness, critical illness and terminal illness. That means that it will pay you as the policyholder tax-free cash benefits even before you die.

Chronic illness is coverage you can compare to long term care insurance.

Critical illness coverage is for conditions like heart attack, cancer and strokes. It typically pays the policyholder around $50,000 per incident.

Terminal illness coverage is for circumstances where your physician certifies that you have less than 2 years to live. At this point the policy will typically pay out 90% of the death benefit to the policyholder.

What Are IUL Lifetime Guarantees?

Thus far we’ve looked at IUL mostly for cash accumulation and not death benefit guarantees. Since we recommend funding these policies to the maximum limits, the guarantee is not that important. We are creating a huge bucket of cash using very little life insurance death benefit.

On the other hand, some people want that lifetime guarantee regardless of the cost. Many companies do offer lifetime guaranteed indexed universal life policies.

Most of these policies can be over-funded, but a guaranteed policy also has a minimum premium that if paid guarantees it won’t lapse until age 120.

These policies still offer the indexing options that can help to grow your cash value for the same needs. They also have the same accelerated benefits.

Withdrawals and loans are also available on these policies and may be used any way that you would see fit. Very little about the policies are different, but the cost to provide the lifetime guarantee can cause your policy to underperform compared to the non-guaranteed policies.

 

why IUL graphic

Conclusion

The thinking behind traditional life insurance purchase is usually how to help your family pay the mortgage and other expenses should you die. IULs are often chosen with a focus on retirement lifestyle. What retirement lifestyle do you imagine? It’s easy to underestimate the cost of your ideal retirement.

Indexed universal life insurance can help bridge the gap between what you have already saved and what you will need in the future.

IUL insurance can be a twofold strategy as part of your financial plan:

Death benefit protection during working years.
Lifetime Tax-Free Income during retirement.

Optimal structuring of an IUL is best done together with seasoned and licensed experts. Ogletree Financial can help. Fill out the quote request form to the right to get started.

Frequently Asked Questions

Yes. It functions like traditional permanent policies but the cash value growth is normally tied to the stock market. You can access this growth at any time during the length of the policy on a tax-deferred and tax-favored basis.

Most IUL policies have a rider that provides living benefits by allowing the insured to get paid a large portion of the death benefit in advance if they are diagnosed with a chronic, critical, or terminal illness. Some companies will also pay out benefits for long-term care expenses.

These are policies that are structured to primarily focus on lifetime insurance coverage while cash accumulation is secondary. This is important to consider since people are living longer because of recent innovations in healthcare.

Since Indexed Universal Life is insurance rather than an IRS controlled investment product, there are no restrictions on how much you can contribute each year to your policy.