IUL FAQs: Answers to Common Questions About Indexed Universal Life

Frequently Asked Questions About Indexed Universal Life

Indexed universal life insurance (IUL) is a flexible, yet complex product. This permanent life insurance coverage offers death benefit protection, as well as a way to grow and protect wealth on a tax-deferred basis. This means that IUL can be used as a financial safety net for loved ones in the future, as well as a method of saving and accessing funds while the insured is still alive.

Not all IUL policies are exactly the same, though, and understanding the nuances of how IULs work can be somewhat complex. With that in mind, it is important to understand how indexed universal life insurance works, and whether or not it may fit in with your financial and estate planning goals. This can start with answering some of the most common, frequently asked questions regarding IUL.

What makes indexed universal life (IUL) different from other types of permanent life insurance coverage?

There are actually several IUL features that make it stand out from other types of life insurance. First, while IUL includes a death benefit and cash value component, the return on the cash is linked to one or more underlying market indexes, such as the S&P 500. This can allow the cash to grow more than that in a whole life policy that offers just a fixed rate.

While the cash value growth in indexed universal life generally has limited upside potential, though (due to caps and/or participation rates), it is also protected from losses when the underlying index(es) performs poorly. This is much safer than variable life insurance where you often have unlimited upside potential, but also the risk of loss. So in many ways, IUL can provide a win-win scenario in terms of risk and reward.

Also, IUL allows for adjustable premium payments, meaning that you can modify your contributions (within certain parameters). This differs from whole life insurance, where you have a fixed premium amount over time.

How does the interest crediting work with indexed universal life insurance?

Knowing how IUL interest works can help to avoid any surprises when you look at your policy’s cash value statement. With indexed universal life, the cash value returns are credited, based on the performance of one or more selected market indexes, like the S&P 500 or Dow Jones Industrial Average (DJIA).

It is important to note that your money is not directly invested in the index, though. Rather, the insurance company uses particular crediting methods to determine how much interest will be added to the cash value.

These IUL crediting methods may include:

• Point-to-point – This method compares the value of the index at the beginning and at the end of a set time period.
• Monthly sum – This IUL crediting method adds up the monthly changes that take place in the index.
• Monthly average – With this method, the index’s value is averaged over a particular time frame.

Understanding Caps and Participation Rates

The pros and cons of IUL policies are that they will have methods in place that limit the upside potential of the cash value (although this is “balanced out” with protection from market losses). For instance, a cap is the maximum amount of interest that is credited. So, for example, if the policy imposes a cap of 8%, and the underlying index generates a 9% return in a given time period, the cash value is credited with 8%. (Note that if the underlying index returns 7% in a given period, then the cash value is credited with 7%).

Likewise, if an IUL policy includes a participation rate, it means that the cash value will “participate” in a certain percentage of the underlying index’s growth. In this instance, if there is a participation rate of 80%, it means that the cash will be credited with 80% of its return.

Therefore, if the tracked index generates a 10% return in a given period, and the policy has an 80% participation rate, then the interest credited would be 8%. (This is because 80% of 10% is 8%).

Some indexed universal life insurance policies have both caps and participation rates included. With that in mind, it is important that you understand all of the parameters in a policy that you’re considering.

What are floor rates in an indexed universal life policy?

Even if the indexes being tracked in an IUL policy perform poorly, most of these policies have a “floor” rate. This ensures that the cash value does not decrease – even during a significant stock market correction.

The floor rate may be 0%, with many of today’s policies offering floors of between 0% and 2%. Given that, if the floor rate is higher than 0% – such as 1% or 2% – it is possible that the cash value could still generate some amount of growth – even during poor market conditions.

What is the annual reset feature associated with IUL?

Each year, the interest that is credited to an IUL policy’s cash value is locked in, and a new starting value is set for the next time period. With this annual reset feature, your principal and your previous gains cannot be lost in the future.

Can you lose money with IUL?

While your money is protected from market losses in the cash value of an IUL policy, there are still some items to be mindful of regarding potential risks with indexed universal life insurance.

For example, there are some fees involved in these policies, including:

• Administrative costs
• Mortality charges (i.e., the cost of the death benefit protection)
• Surrender fees (if you cancel the policy or withdraw more than the allotted maximum amount in the early years)
• Taxes (gains that are withdrawn from the indexed universal life insurance cash value are taxable)

In addition, if the cash value does not grow enough to cover the costs of the policy, you could be required to pay additional premiums in order to keep it active. Further, if you borrow money from the cash value, there are typically interest charges incurred. These may also reduce the amount of your cash value over time.

How much does indexed universal life insurance cost?

There are several factors that go into the pricing of an indexed universal life insurance policy, such as:

• Your age and health condition at the time of application
• Death benefit amount
• Administrative fees
• Cost of any additional riders added
• Insurance company offering the policy (some insurers charge different premium rates, even with the same amount of death benefit coverage, on IUL policies)

How can IUL policy holders alter their premium payments?

Indexed universal life insurance policy holders typically have some flexibility with regard to the timing and amount of their premium payments. For example, you may be allowed to raise the premium in order to place more into the cash value. You could also lower the premium amount if necessary (as long as there is enough to keep the policy in force).

If there is already a sufficient amount of money in the IUL policy’s cash value, you may be able to reduce, or even skip, premium payments by using funds from here to cover the costs. Some IUL policies allow even more flexibility by enabling the policy holder to make adjustments to the death benefit and/or to transfer funds between the death benefit and the cash value component.

Keep in mind that if you take any withdrawals or loans from the IUL policy’s cash value component, though, it could have a negative impact on any future premium costs and obligations.

Who is a good candidate to purchase indexed universal life insurance?

Although indexed universal life insurance is not well suited for everyone, it may be a good fit for those who are seeking both death benefit protection and long-term tax-advantaged financial growth potential without the risk of market losses.

How can you obtain a quote for indexed universal life?

You can obtain a quote for IUL by contacting an insurer that offers this type of coverage. Because all companies and policies can differ, though, it is often easier to work with a specialist who is not beholden to one specific company and who has access to numerous insurers. That way, you can instantly compare information and premium prices for multiple different options. From there, you can narrow down which one – if any – is right for you.

Is IUL Worth It?

Given all of the IUL pros and cons, this financial vehicle may or may not fit into your overall financial or estate plan. Given the recommendation that IUL is a long-term product, though, it is vital that you not purchase it prior to a complete evaluation.