What are the pros and cons of indexed universal life insurance?
Indexed Universal Life (IUL) insurance is designed to provide permanent life insurance coverage while allowing cash value accumulation linked to an external stock market index, like the S&P 500.
Unlike traditional whole life insurance, which offers a guaranteed growth rate, IUL typically provides a cash value floor of 0%, meaning the cash value won’t decrease, even in poor market years.
The cash value growth in an IUL is not directly tied to the actual performance of the stock market index but is instead calculated based on a formula defined in the policy terms, which can sometimes lead to capped growth.
Policyholders can often borrow against their cash value through loans, but they must understand that unpaid loans, along with any interest accrued, reduce the death benefit payout when the insured passes away.
IUL policies offer flexible premium payments, enabling policyholders to adjust their contributions according to their financial circumstances, which is different from fixed-premium whole life insurance.
The interest credited to the cash value accounts in IUL policies is subject to participation rates, meaning only a portion of the market index’s returns contribute to the cash value growth, limiting how much investors benefit from index performance.
IUL policies often include various fees and charges, including cost of insurance, which can affect the overall cash value growth and reduce the available cash upon withdrawal.
Unlike term life insurance, which provides a death benefit for a specified period, IUL insurance is permanent, providing lifelong coverage as long as premiums are paid.
Indexed universal life insurance can be used as a supplementary retirement strategy since the cash value can be withdrawn or borrowed tax-free under certain conditions, allowing greater tax efficiency.
The market index linked to the IUL's growth can be selected by the policyholder, but they must be cautious; indexes have different behaviors, and choices can dramatically affect cash value growth.
The complexity of IUL products can be a disadvantage; understanding the rules for how cash value increases are calculated requires careful study and sometimes financial advice.
Many state regulations surrounding life insurance, including IUL, ensure that policies are sold with full transparency about risks and benefits, but not all insurance agents fully disclose these details.
One surprising aspect is that the returns of the cash value component may lag behind those of other investment vehicles like mutual funds or ETFs, just when you might expect it to perform similarly.
IUL insurance could potentially underperform compared to market averages during long bull markets due to cap limits set on index returns while also not benefiting from significant downturns.
Insurers may impose a surrender charge if the policy is canceled or the cash value withdrawn before a certain period, which can significantly impact the return on investment.
The potential for building wealth through IUL is tied to market performance but is unclear because of the diverse range of factors such as policy fees, market caps, and the fact that insurance is not a guaranteed investment vehicle.
Policyholders must consider their long-term financial goals carefully; IUL may provide temporary relief in cash value and taxes but may not suit those looking strictly for investment.
IUL products are not particularly intuitive; many people may find it challenging to compare them directly against other life insurance or investment products due to unique features like caps, floors, and fees.
A significant disadvantage of IUL may be the impact of rising interest rates, which can affect the cost of insurance and the cash value growth, leading to increased premiums or reduced returns.
Finally, there has been a growing trend of regulatory scrutiny on indexed life insurance products, which could lead to changes in how these policies are structured and sold in the future, possibly affecting their appeal and performance.