For instance, if the policy is purchased at a time when the market is performing poorly, the owner may wind up with high premium payments that have no effect whatsoever on the cash value.
If the premium payments are not made on time later in life, the policy may then expire, thereby defeating the purpose of life insurance.
TABLE OF CONTENTS LIFE INSURANCE POLICY TYPES The Advantages and Disadvantages of Indexed Universal Life Insurance By Kimberly ROTTER Updated November 22, 2022 ANTHONY BATTLE Life insurance comes in a variety of forms and can assist in providing some financial relief to you and your loved ones in the event that you pass away. It can be hard to know which type to choose, from whole to term and universal to variable. especially when you include unique insurance products like indexed universal life (IUL) insurance.
You can reap the benefits of market gains while building a cash value with this kind of policy. IUL, also known as equity-indexed universal life insurance, guarantees a payout to your heirs in the event of your death. IUL, like other forms of universal life insurance, has a cash value that grows in proportion to paid premiums. If you cancel the policy, you can get the cash value or use the money to take out a loan and use it for other things.
1 The premiums for these policies go toward term life insurance that can be renewed annually. After fees are deducted, the remainder is added to the policy’s cash value. Interest is paid on the cash value based on changes in an equity index on a monthly or annual basis. Before buying IUL insurance, it’s important to know how it works because some people may find it useful. When compared to other types of life insurance, there are numerous benefits and drawbacks.
Important Takeaways Indexed universal life insurance policies offer greater upside potential, flexibility, and gains that are not subject to taxation.
As long as the premiums are paid, this kind of life insurance provides coverage that lasts forever.
Limits on returns and no assurances regarding premium amounts or market returns are among the disadvantages.
If you stop paying your premiums, you risk losing your IUL insurance policy.
If you want options for a tax-free retirement and have significant upfront investments, IUL policies are typically the best option.
How Indexed Universal Life Insurance (IUL) Works IUL insurance is marketed as a cash-value policy that reaps tax-free market gains without incurring loss in a downturn in the market.
2 A market index, such as the S&P 500 or the Nasdaq 100, can be linked to a portion of the policy’s cash value by the insured. The policy’s rate of return changes in tandem with the index’s upward and downward movements. The maximum amount you can invest, up to 100 percent, varies between policies.
2 In the event that the indexed account experiences gains, a percentage of the interest income—the participation rate—is added to the policy’s cash value (usually calculated over a month). This usually happens once every year or every five years. Therefore, assuming a 4% gain, a participation rate of 50%, and a total cash value of $10,000 at the present time, As a result, the cash value is increased by $200 (4% x 50% x $10,000 = $200).
The account receives very little or nothing if the value of the index stays the same or falls. But there is one advantage: The insured is shielded from financial ruin.
IULs are not considered investment securities, despite the fact that they perform like securities. Jordan Niefeld, CPA, CFP, of Raymond James & Associates in Aventura, Florida, stated, “The cash value is not actually invested in the market or an index.” The cash value account’s interest crediting rate is simply calculated using the index.
It is essential to conduct research to ensure that your insurance provider is a reputable universal life insurance company, as is the case with any type of universal life insurance.
Advantages of Indexed Universal Life Insurance Higher Potential for Returns One significant advantage of IUL insurance is the possibility of gains in the cash value that may be greater than those on other types of life insurance, such as traditional universal life or whole life insurance policies.
Additionally, policyholders benefit from a crediting floor, which typically ranges from 0% to 1%. This means that the current cash value is protected from losses in a market with poor performance.
3 Niefeld stated, “The client does not participate in a negative crediting rate if the index generates a negative return.” To put it another way, the account won’t lose any of its initial cash value.
Advantages in Taxation for Capital Gains The death benefit is exempt from taxation for beneficiaries, and the cash value accrues tax-deferred. In many instances, loans secured by the policy are also tax-free. Since premiums are paid with money left over from taxes, both partial and complete withdrawals—up to the amount paid in premiums—are exempt from taxes.
4 Death Benefit IUL insurance, like other types of life insurance, can pay out a benefit to your heirs in the event of your death. This cash can be put to use for:
Cover outstanding debts like mortgages and co-signed student loans, pay for children’s college tuition, and cover day-to-day living costs with this death benefit, which is tax-free for your beneficiaries.
5 There is no effect on Social Security Social Security benefits may be a significant source of retirement income. You can start receiving Social Security benefits at age 62 or put off receiving them until you are 70. Working while receiving benefits can reduce your benefit amount, as can taking benefits before reaching full retirement age. Before your benefits are reduced, you can only earn a certain amount per year before reaching full retirement age.
3-4 The accumulation of cash value from an IUL insurance policy and any loan amounts borrowed would not count toward the earnings thresholds. As a result, you could borrow against your policy to increase your Social Security benefits without having to reduce them.
Additional Benefits A variety of riders, or additional provisions, can increase the value and appeal of the policy, such as provisions for long-term care and critical illness and guaranteed premiums.
Disadvantages of Indexed Universal Life Insurance There are a few possible disadvantages of IUL policies. For instance, if the policy is purchased at a time when the market is performing poorly, the owner may wind up with high premium payments that have no effect whatsoever on the cash value. If the premium payments are not made on time later in life, the policy may then expire, thereby defeating the purpose of life insurance.
Below, we’ve listed a few potential drawbacks.
Limited Gains The insurer restricts increases in the cash value. In most cases, insurance companies have minimum participation rates that are less than 100%, and in some cases, they can even be as low as 25%. In addition, in prosperous years, returns on equity (ROE) indices are frequently capped at particular amounts. Regardless of how well the underlying index of the policy performs, these restrictions can limit the actual rate of return that is credited to your account each year.
If that’s the case, you might do better investing directly in the market or looking into variable universal life insurance instead. However, it is essential to take into account your individual risk tolerance as well as your investment objectives to guarantee that neither one conflicts with your overall strategy.
By keeping some of the gains, including anything above the cap, the insurer makes money.
