I am purposely taking a long time on life insurance. It can be an integral part of you giving so I want to help you understand as much as possible. Today we will look into IUL. Indexed universal life insurance (IUL) is a type of permanent life insurance. It stays in force as long as you stay current on your premium payments or until you reach the maturity date specified in the policy. Many IULs mature when the insured person reaches age 121.
Similar to whole life, IUL has a cash value component. But the gains in an IUL are benchmarked to an index like the S&P 500. While the cash value growth is linked to the index, the insurance company actually invests in things like bonds, mortgages, certain treasuries and in some cases, options contracts.
Standard Universal life insurance offers flexibility to your premium payments. You can skip payments if needed, but only within specified limits. There needs to be enough in the cash value. The main difference between indexed universal life insurance and other universal life insurance policies is how cash value accumulates. That is where the index comes in.
How Indexed Universal Life Insurance Works
Cash value accumulation
The cash value of an IUL policy is tied to the performance of an underlying index, such as the S&P 500 or the Nasdaq composite. But the premiums are not directly invested in that index. The insurance company uses the index’s rate of return and a formula to determine how much the account should be credited. If the index has gained value, your cash value will rise. IUL policyholders are generally protected from a drop in the index because of a “floor.” The interest rate credited to the account will never be less than the floor, which is often 0%. So if your index lost 10%, 0% will be credited, instead of minus 10%, and your cash value won’t lose 10%. You can borrow against your cash value through a policy loan or withdraw cash value. When you die, your beneficiaries receive a death benefit, but the death benefit amount will be reduced by any loans not paid back or withdrawals you’ve taken from the cash value. All similar to whole life. You can typically choose from one or several indices, depending on the insurance company. Most IUL products also offer a fixed (declared) interest rate option in addition to the index-linked investment.
Floors, caps and participation rates
• Floor: The floor is the minimum rate that will be credited to your cash value. Most floor rates are 0%. That means you will be protected from losses in the index. You cannot experience any market loss in the policy. It should be noted, however, that the account value can be reduced because of costs but not the market. The floor is guaranteed and will not change while you own the policy.
• Cap: or ceiling. this means the amount credited to your cash value during each indexing period won’t go above a certain percentage – even if the index performs above that cap. For example, if your cap is 10%, and the index goes up 12%, the amount credited to the account increases by 10%, not 12%. The cap can be changed while you own the policy in response to market flucuations.
• Participation rate: Your cash value gains are also calculated according to the “participation rate,” which is set by the insurance company. This is the portion of the index’s return that is credited to your account. It can often range anywhere from 25% to above 100%. If the IUL has a participation rate of 100%, you will earn all of the interest gained by your investments, up to your cap
In contrast, if the participation rate is 50% and the index gained 10% for the month, you’d actually earn 5% for the period. Though the growth is often tracked monthly, the cash value earnings are usually credited to the account once per year or every two years and sometimes more depending on the contract. The insurer can change the participation rate (and cap rates) for any index account in response to market conditions. Usually this is done annually during the time you own the policy. But you also have the option of changing the index and the allocations as well.
Flexible premiums and death benefit
You have the option to adjust your premiums and death benefit amount if needed. If your account accumulates enough value, you could use those funds to pay your premiums. If you decide to underpay or even skip a premium, the cost of insurance charges and policy expenses will nonetheless be deducted from your cash value account every month. So long as the cash value account is sufficient to cover these monthly deductions, then the policy will remain in force and the death benefit will continue to be payable. On the other hand, there may be instances when you are required to pay more in premiums for an IUL than you expected. For example, if the index performs poorly and you are credited only 0%, the subtraction of monthly policy charges could cause the cash value to drop and your policy could lapse without an infusion of more premium. If your cash value falls too much, the insurance company could put out a “premium call,” meaning you need to put in more money to avoid a policy lapse. If your policy
lapses, you lose out on all the money you put in, plus the death benefit. Again, making it imperative to work with an agent skilled in these types of policies.
What Happens When an Indexed Universal Life Insurance Policy Matures?
Whenever any life insurance policy matures (including an IUL), the benefits specified in the policy contract are paid out. This is called a policy endowment. The benefit paid out at maturity will be equal to the full death benefit. The IRS doesn’t regard that payment as a death benefit under Section 101 of the Internal Revenue Code so it is taxable. As an endowment, these otherwise tax-free proceeds become fully taxable at ordinary income rates.
Some life insurance policies include language that extends policy maturity if the insured person is still living on the maturity date. In these cases, the death benefit is paid at death even after the original policy maturity date and thus received tax-free by the beneficiaries.
Is Indexed Universal Life Insurance Right for You?
IULs can be a good fit for people who want to participate in market performance but who may not want to have full financial exposure to market downturns. It can be a good fit for those that are willing to forgo some guarantees for more potential gain. Also, for any who have maxed out their available retirement plans, an IUL could allow them to contribute with fewer age restrictions and potentially grow cash value on a tax-deferred basis and possible tax-advantaged withdrawals.
Cost of Indexed Universal Life Insurance
When shopping around for an IUL policy, you’ll be shown projections of the policy’s potential growth. These illustrations are based on predicted interest rates, fees and more. However, because it’s impossible to predict what the market will do in the future, these (likely optimistic) numbers are only estimates and not guaranteed. Make sure to focus on the guaranteed parts of the policy illustration, and don’t assume your outcome will match the non-guaranteed projections.
Any one considering an IUL should ask that any and all proposals include year-by-year cost disclosures and performance requirements. Be sure to ask how premiums, fees and interest rates will impact the policy’s overall performance.
In order to keep up with the policies’ performance, it is good to request policy in-force policy illustrations after you have owned the policy for a while. Especially if you’re considering a cash value loan. You’ll want to know if taking a cash value loan could potentially lead to a policy lapse
Pros and Cons of Indexed Universal Life Insurance
Indexed universal life insurance can be fairly complex, so it’s important to understand how it works before committing to a policy. While there may be more potential upside with indexed universal life insurance versus other types of permanent life insurance, there are also more risks and costs. It’s important to work with an experienced life insurance agent or financial advisor to understand IULs before buying one.