Indexed Universal Life Insurance

There’s a cash value component in IUL that’s often tied to a stock market index, such as the Nasdaq-100, S&P 500 or a combination of indexes. You might also have the option of a fixed-interest investment. When you pay premiums, part of the money goes to (potentially high) policy fees and charges, and the remaining goes into cash value. It’s important to understand the boundaries of your potential investment gains. Indexed universal life insurance policies have participation rates and caps. The participation rate is a portion of the index gains that your cash value will actually receive. For instance, if your index went up 10%, and you have a participation rate of 50%, you’ll gain 5% upside. Additionally, there’s usually a cap, which is the maximum percentage you can gain no matter how well the index performs. If your index plummets, you’ll still have a “floor” that guarantees a minimum return rate, which can be 0%. Still, it’s possible to lose all your cash value if policy charges and expenses eat through your money. Owning an IUL policy doesn’t mean that your money is actually invested in the index. In reality, insurers still mainly invest in bonds. So the index is just a barometer to calculate cash value gains and losses. And the calculation of your gains won’t include any dividends that you might otherwise pocket if you invested directly.

Higher Return Potential
These policies leverage call options to gain upside exposure to equity indexes without the risk of losses, while whole life insurance policies and fixed universal life insurance policies provide only a small interest rate that may not even be guaranteed. Of course, the annual return that you see with an IUL insurance policy will depend on how well its underlying index performs. But your insurance company can still offer a guaranteed minimum return on your investment.

Greater Flexibility
IUL insurance can offer flexibility when putting together a policy that’s designed to meet your investment goals. Policyholders can decide how much risk they would like to take in the market, adjust death benefit amounts as needed, and choose among a number of riders that make the policy customizable to their needs. For example, you may choose to add on a long-term care rider to cover nursing home costs if that becomes necessary.

Tax-Free Capital Gains
Policyholders do not pay capital gains on the increase in cash value over time unless they abandon the policy before it matures, whereas other types of financial accounts may tax capital gains upon withdrawal. This benefit extends to any loans that you may take from the policy against your cash value. Having a ready source of cash that you can borrow against may be appealing if you want to avoid triggering taxes and penalties with an early withdrawal from a 401(k) or IRA.

No Social Security Impact
Social Security benefits may be an important source of income in retirement. You can begin taking Social Security as early as age 62 or defer benefits up to age 70. Taking benefits ahead of your full retirement age can shrink your benefit amount, as can working while receiving benefits. You’re only allowed to earn so much per year prior to reaching full retirement age before your benefits are reduced.

Death Benefit
IUL insurance, like other types of life insurance, can provide a death benefit for your loved ones. This money can be used to pay funeral and burial expenses, cover outstanding debts such as a mortgage or co-signed student loans, fund college costs for children, or simply pay for everyday living expenses. This death benefit can be passed on to your beneficiaries tax-free.