Life insurance is difficult to understand. The only thing that is obvious is what financial advisor Dave Ramsey said about it. “Its only job is to replace your income when you die,” especially if family members will still depend on you. There are basically two different ways to provide income for your family, which include term life insurance and permanent life insurance. Universal and indexed universal life insurance fall under the permanent life insurance umbrella. A thorough understanding of how indexed universal life (IUL) insurance works is necessary to determine if it might be right for you and your family. Here is our IUL policy guide.
Universal and indexed universal life insurance are types of permanent life insurance. They offer low premiums and ways to build cash value through investment savings. They offer more flexibility than whole life insurance because premium payments and death benefits can be adjusted at any time during the length of the policy. The main difference is that indexed universal life insurance is not based on a fixed interest rate. Instead, its performance is linked to a stock market index like the Dow Jones, Nasdaq, or the S&P 500. When the market does well, the policy’s cash value grows, but at the same time, no money is lost if the market falls.
All life insurance policies fall under one of two definitions:
What is indexation in life insurance? In the case of indexation in life insurance, the money is invested in a stock market index.
When the monthly premium is paid, the money is divided for different purposes. Some of it pays for the insurance itself, and some of it pays for fees or other costs. The rest of it is designated toward the cash value of the policy. This occurs when the insurance company invests this money in the equity index of a stock market index. In general, indexed universal insurance policies offer a guaranteed minimum fixed interest rate and a choice of indexes for the policyholder.
Investing in an index is not the same thing as investing in the stock market. Rather than measuring the performance of an individual stock, the overall performance of the index is measured. For example, the value of the chosen index is recorded at the beginning of each month so that it can be compared to the value at the end of the month. If an increase is seen, the interest from the investment is added to the cash value of the policy either monthly or annually as set forth by the insurance company.
When the value of an individual stock goes down, the stockholder loses money. Conversely, if the value of the index goes down, the policyholder gains nothing and loses nothing, but the value must increase for the policyholder to gain anything.
The purpose of both programs is to ensure future income, but there are drastic differences. A 401k is an investment and savings plan that offers tax breaks on money contributed by the employee, while the indexed universal insurance is paid for using after-tax dollars. The resulting income stream is then tax-free.
Indexed universal life insurance policies are attractive for many reasons, including:
These policies also present some drawbacks, including:
Choosing a policy can be just as confusing as understanding how a policy works. Depending on who you seek advice from, you may be presented with skewed views about the appropriateness or the pitfalls of indexed universal life insurance policies. For example, a life insurance agent who wants to push you toward an indexed universal policy will only tell you about the pros of your decision and will ignore or skirt the possible cons. On the other hand, agents who want to sell other whole life policies will exaggerate the possible downsides of indexed universal insurance policies according to their own agendas. If you decide to do some research online, be prepared for a myriad of opinions, some qualified and some not, from people who may misuse the information to steer clients toward other insurance options.
Your best course of action is to find an insurance agent who has a reputation for being honest and who will present all your options without bias. Ideally, he or she will be able to provide an indexed universal insurance policy guide and fully inform you about IUL insurance pros and cons.
Not every policy is right for everyone, but there are people who are better suited for indexed universal policies. People who want to be able to earn interest while knowing that their benefits are fixed and guaranteed will find indexed universal policies most attractive. A qualified insurance agent or financial planner should be able to evaluate your needs and recommend the right policy for you.