Indexed Universal Life Insurance (IUL) is a permanent life insurance policy providing death benefit protection and the potential for downside protected cash value growth based on an index like the S&P 500. 

In this article, we will explore IUL and discuss the pros and cons of this type of insurance.

This article is written as general education, and should not be considered as personal financial advice. If you would like personal guidance with life insurance, you can schedule a time to talk with one of our experts.

Indexed Universal Life Insurance: An Overview

IUL insurance is typically positioned as permanent life insurance with the potential for tax-deferred cash value growth that has upside potential and downside protection.

The cash value accrues interest based on the performance of an underlying stock market index or fixed account. 

The cash value of the policy fluctuates depending on whether the index goes up or down, but the interest can generally not go lower than 0%, which means that your downside is protected.

The insurance company might provide a minimum rate of return that is guaranteed in the fixed account and some indexed accounts may have a cap, or a maximum yearly interest that it can be credited.

Compared to whole life insurance, which provides a guaranteed dividend, IUL insurance is riskier. But, it is considered less risky than variable universal life insurance, which allows you to invest money directly in accounts that function similar to mutual funds.

Index Universal Life Insurance Benefits

Let's look more closely at some of the significant benefits of incorporating IUL into your financial strategy.

Enhanced Return Prospects

Unlike whole life insurance plans that may offer non-guaranteed dividends or a guaranteed cash value; Index Universal life offers an index option that may provide more upside potential while still protecting the downside.  

The performance of the underlying index will impact the annual return you receive from an IUL insurance policy if your cash value is allocated to an indexed account.  

Some carriers may provide several indexed indexed account options inside of the policy. Different indexed options usually consist of different indices like S&P 500, Hang Seng, FTSE etc. or different cap and floor rates like uncapped, multiplier, 0% floor, 10% cap etc. 

Most indexed accounts have a required amount of time that the cash must be left in the index before any interest would be credited (e.g. 1 year, 5 years etc.). Most credited interest is also based on a specific start date and specific end date (e.g. 1st of the month, 15th of the month etc.). 

Participation rates for index options are particularly important. Participation rates are the percentage of the indexes gain that would be credited to the cash value inside the account. For example, if the policy has a participation rate of 75 percent, then the index-linked returns would only amount to 75 percent of the gains associated with the index. 

Many people falsely believe that an index option can’t lose principal. Placing money in an index fund that has a guaranteed floor of zero still could lose value if monthly charges and expenses are removed from that investment. It is important to note what the guaranteed floors are and when any floors or caps are subject to potential movement by the carrier.  

Greater Flexibility

IUL insurance can provide greater flexibility than term or whole life when creating a plan to help you reach your financial goals. 

Premium payments on IUL are flexible and you have the ability to change them at any time during the life of the contract. If there is enough cash value built up in the policy to pay monthly charges and expenses, you may even be able to skip or stop making premium payments.

You can also choose to put in excess premiums at any time to improve cash value/death benefit or pay your policy off sooner than originally illustrated. 

Some may choose to use IUL to supplement their retirement plan due to the tax efficient growth and disbursement options it provides. 

If you are using life insurance as a supplement know that due to the front end loading of charges it will take time to build cash value in the contract. 

There is a lot of flexibility to the death benefit. As long as you have not purchased the minimum face amount offered, you can typically reduce your death benefit. 

You can also usually choose to have a variable death benefit that would add the cash value to the death benefit upon the insured's passing. Caution this option may cost more in charges than a fixed death benefit option due to the net amount of insurance at risk.

The carrier may offer riders that can be added to the IUL. For instance, you might add a long-term care/chronic illness rider.

Capital Gains Are Not Taxed

Capital gains tax is due when you sell a stock or mutual fund for a profit inside a taxable account. In contrast, holders of index universal life insurance plans do not pay capital gains on the growth in cash value.

Index universal life policies grow tax-deferred. The tax-deferred advantage also applies to any policy loans, unless the policy is a MEC. Learn more about MEC and IRS tax treatment of life insurance in this article. 

If the policyowner was to choose to cancel their policy, remove more money than the cost basis, or the policy has been classified as a MEC, accessed profits may be taxed as ordinary income and incur penalties.

IUL’s have surrender penalties in the early years (usually 10-15) if the policyowner was to take withdrawals or cancel. 

IUL withdrawals are taxed on first in first out basis (FIFO) unless the policy is a MEC. MEC contract withdrawals would be considered last in first out (LIFO) and be subject to a 10% penalty if removed before 59.5 years of age.

IUL’s do not have a min age requirement for accessing cash value unlike 401ks and IRAs which typically have 10% penalties for removal of money before 59.5 years of age and are a LIFO (last in first out) and taxed as ordinary income. 

Conclusion 

Indexed Universal Life Insurance (IUL) is a permanent life insurance policy with the potential for tax-deferred cash value growth that has upside potential and downside protection. 

It is an attractive life insurance option for those looking to pay for final expenses, supplement retirement, or pass on a legacy to their heirs. 

White Swan is a digital broker that provides access to the universe of life insurance solutions, and can help you build tax-advantaged wealth and keep your loved ones or business protected.

Our streamlined platform makes it simple, transparent, and quick to get the optimal policy for your needs and circumstances, straight from one of America’s top carriers.

To get started you can request a personal plan online or schedule a call with one of our industry experts.