Indexed Universal Life Insurance 101

Insurance, Life Insurance

When it comes to life insurance, there are so many different options and “flavors” that deciding which type of policy is right for you can be difficult and confusing. Not to complicate matters even more, but there is one type of insurance that you might want to add to the flavor mix if you are shopping for life insurance: indexed universal life, or IUL.

IUL is a form of universal life (UL) insurance, which is itself a form of whole life insurance. Whole life insurance is also sometimes referred to as permanent insurance because it provides protection for as long at the insured lives, instead of just for a period of years, like term life insurance.

Cash Value and a Death Benefit

Policies under the whole life umbrella allow policyholders to build up cash value within the policy on a tax-deferred basis while still enjoying a death benefit. Accumulated cash value can be tapped for a variety of needs, including retirement income.

Depending on the type of whole life insurance, policyholders can invest their cash value in a variety of different vehicles via what are called subaccounts. Indexed universal life allows policyholders to invest their cash value in an equity index account, like the S&P 500, Russell 2000 and Nasdaq 100.

Indexed universal life insurance is similar to variable universal life insurance (VUL), with one key difference: VUL policyholders can invest their cash value in stock and bond subaccounts that are similar to mutual funds. Conversely, an IUL’s cash value can only be invested in an index account. This tends to make IUL policies less volatile than VUL policies.

In addition, IUL typically offers a guaranteed minimum fixed interest rate over the long term, and the principal is generally protected from loss, which makes IUL less risky than VUL. At the same time, though, there may be a cap on the accumulation percentages of an IUL policy, which effectively limits the return potential. In other words, IUL generally features less risk than VUL, but also lower potential return.

How an IUL Policy Works

A portion of each IUL premium payment goes to pay for the insurance component of the policy, another portion goes to pay fees, and the rest goes to cash value. The amount of interest credited to the policy is calculated based on the difference in the value of the selected index at the beginning and end of the month, with gains credited to the policy on a monthly or annual basis.

For example, if the selected index gained 4 percent during the month of October, 4 percent of the current cash value would be added to the policy’s total cash value. If the index goes down in October, no interest is added to the cash value — but no cash value is subtracted, either.

Note that the insurance company can set a percentage rate that effectively limits the amount of interest that can be credited to an IUL policy. This participation rate generally ranges from 25 percent to more than 100 percent. So if the selected index gained 4 percent in October, the cash value that month was $20,000 and the participation rate was 50 percent, then $400 would be added to the cash value [(.04 x 20,000) x .5 = $400].

IUL is just one of many different types of policies you should consider if you are shopping for life insurance. Given all the different life insurance options and their complexity, it is a good idea to talk to a financial planner and life insurance expert for help in choosing the right kind of policy for you and your family.

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Photo © Frazao

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