What is Indexed Universal Life Insurance?

Indexed universal life (IUL) insurance is probably one of the coolest things the insurance world has come up with. They've been around for a while, but over the last 20 years have been used by policy holders to grow their retirement income. What makes it so desirable is the ability it gives you as the insured the ability to borrow against it while the principal amount doesn't go down. It's like having your cake and being able to eat it too!

Simply put, it's a type of permanent life insurance that provides both a death benefit and a cash value component, similar to other types of universal life insurance. However, the key distinction is that the growth of the cash value is tied to the performance of a specific stock market index, such as the S&P 500, rather than earning a fixed interest rate.

Here are the key features of indexed universal life insurance:

1. Permanent Life Insurance :

Like other types of permanent life insurance (e.g., whole life or universal life), IUL provides lifetime coverage as long as premiums are paid.A portion of the premium goes toward the death benefit, while the rest is invested in the cash value component.

2. Cash Value Growth Linked to Market Index :

The cash value grows based on the performance of a selected stock market index (like the S&P 500), but the policyholder does not actually invest directly in the stock market.There’s typically a cap on the maximum return the cash value can earn (e.g., 8-12%) and a floor that limits the losses in down markets (often 0%), which protects the policyholder from losing money if the index performs poorly.

3. Flexible Premiums :

IUL policies allow for flexibility in premium payments. You can adjust how much you pay, provided there’s enough cash value in the policy to cover the cost of insurance and other fees.

4. Tax-Deferred Growth :

The cash value in an IUL policy grows tax-deferred, meaning you won’t pay taxes on the gains while the money stays in the policy. Policyholders can also borrow against the cash value, often without paying taxes on those loans.

5. Death Benefit :

The policy offers a death benefit for beneficiaries upon the insured’s death. It can either be a fixed amount or an increasing amount based on the growth of the cash value.

6. Downside Protection with Upside Potential :

One of the main attractions of IUL is that it offers upside potential from stock market gains while providing downside protection due to the floor. This means you can participate in a portion of market gains without the risk of losing cash value in a market downturn.

7. Costs and Fees :

IUL policies can have relatively high fees and charges compared to simpler policies like term life insurance. These fees include cost of insurance, administrative fees, and other charges, which can eat into the policy's cash value growth if not managed carefully.

8. Flexibility in Withdrawals and Loans :

Policyholders can withdraw or borrow against the cash value of their IUL policy. Withdrawals are typically tax-free up to the amount of premiums paid, and loans against the policy’s cash value may also be tax-free, but they reduce the death benefit if not repaid.

IUL insurance can be appealing to people who want permanent life insurance coverage with the potential for higher returns on their cash value, along with downside protection. However, it’s important to understand the fees, caps, and potential complexity involved in managing an IUL policy.