Indexed Universal Life insurance (IUL) is a type of permanent life insurance policy that offers both a death benefit and a cash value component that may be invested in an index (e.g. S&P 500, FTSE, Hang Seng etc.) that provides downside protection and upside potential tied to the growth of the index.
This type of policy has gained popularity as a potential investment vehicle due the protection that it provides during an insured’s working years and due to its potential for tax-efficient growth and tax-deferred access to cash value.
Is an IUL a good investment? If you've always wanted to know the answer to this question, then read on. In this article, we will explore the pros and cons of investing in an IUL policy.
If you would like to find the right policy for you White Swan can help.
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.
Pros of IUL
1. Death Benefit
Unlike traditional retirement products, stocks, or mutual funds, IUL policies offer a death benefit, which can provide a much larger pool of money than the accumulated cash value in the event of the policyholder's death.
In traditional retirement products, stocks or mutual funds, the balance of the account is the value provided at death.
The death benefit on an IUL is typically free of ordinary federal income tax, if there is a properly structured ownership and beneficiary arrangement.
2. Potential for Growth
The cash value inside IUL policies can be allocated to different accounts where it can grow over time, with downside protection.
IUL policies offer different investment options which can vary from insurer to insurer.
Typically, most insurers provide at least one fixed account and an indexed account option, and some offers a wide selection of different types of accounts.
Fixed accounts have a minimum guaranteed interest, but will often yield a higher interest than the guaranteed minimum.
Index accounts are linked to some type of index such as the S&P 500, FTSE, Hang Seng, or EURO STOXX.
These accounts feature a floor, which is the minimum amount of interest that the account can earn, which is generally never lower than 0% (ie. you are protected against losses).
Some accounts also has a cap, which is a maximum amount of interest that the account can earn. There are also uncapped account, which usually have other limitations on growth than a hard cap.
If a certain index performs well, the cash value in an indexed account may grow at a higher rate than what it would in a fixed account.
Transversely, if the index performs poorly, the floor would protect against catastrophic loss, but the fixed account would likely yield a higher interest.
Most policy owners will allocate their cash value into several accounts and select a percentage allocation for each depending on their current goals, their financial situation, and the state of the market.
Account allocations can also be changed over time, which is why It is important to monitor the performance of the policy and regularly review the allocation to ensure that the policy is properly structured and that the investment is growing as intended.
3. Tax-deferred Access to Cash Value
One of the most significant advantages of an IUL policy is the ability to access the cash value tax-deferred.
Unlike traditional investments, such as stocks and mutual funds, the cash value inside an IUL policy is not subject to capital gains tax when there is a realized gain. IUL policies grow tax-deferred, and may continue to be deferred as long as the policy stays in-force.
When distributing money from the policy, most policy owners will typically first withdraw the cash value up to the cost basis, and then take policy loans for additional money. This is done to ensure that money can be accessed from the policy without any taxes due.
Withdrawals are generally considered a return of premium and are therefore not taxable as ordinary federal income.
If the policy owner withdraws more than the cost basis or the policy has been overfunded according to IRS guidelines (a so called MEC-policy), withdrawals or loans could be taxable as ordinary federal income and there may be penalties.
At this point, loans are usually still accessed without income taxes, assuming that the policy has not been classified as a MEC.
If the policy is in-force, any outstanding loan would be paid off by the death benefit at the time of the insured’s death.
Typically, the death benefit pays to the beneficiaries free of ordinary federal income tax.
In general, IULs have several pros which can be beneficial for individuals who are looking for protection during their income earning years and a tax-efficient way to supplement their retirement income but want downside protection and potential growth tied to stock markets.
Cons of IUL
IUL policies can be complex and confusing, making them difficult for some individuals to understand.
The policy's performance is linked to the performance of an index, which can be volatile and difficult to predict.
Additionally, the policy's fees and charges can be subject to change, which can eat into the cash value growth.
At White Swan, we've made IUL plans significantly easier to understand, and have industry experts that can help you determine if IUL is right for you, and which insurer and product would be suitable for you.
To explore how an IUL would work for you is easy - just request a personal plan through our digital platform.
2. Surrender Charges
IUL policies typically have surrender charges, which are fees charged by the insurance company if the policy is surrendered (canceled) in the first 10-15 years of the contract.
These charges can be significant and can eat into the cash value growth if the policy owner decides to surrender the policy early.
To use an IUL in the most optimal way, however, it is highly advisable to keep the policy in force until the insured person dies.
This is because beyond surrender charges, there may be additional tax consequences from surrendering an IUL prematurely.
In conclusion, an IUL should not be considered as a short-term cash vehicle, but rather as a long term investment.
3. Not a Guaranteed Investment
While IUL policies offer the potential for cash value growth, growth is usually not guaranteed inside indexed accounts.
The policy's cash value growth is linked to the performance of an index, which can be volatile and unpredictable.
Additionally, policy fees and charges can eat into the cash value growth, creating a negative rate of return even if the index has a guaranteed 0% floor.
Who Should Consider IUL?
Individuals who are maxing out their current traditional retirement accounts and looking for a tax-efficient way to supplement their retirement income while still providing financial security for their loved ones may be great candidates for an IUL.
Additionally, individuals who are willing to take on some risk in exchange for potential growth may find an IUL policy to be a good investment.
However, it is essential to understand the policy's fees and charges, surrender charges, and the policy's potential for growth before investing in an IUL policy.
Know that using a life insurance policy to supplement your retirement income takes time for the investments to grow.
Most IUL policies should be allowed to grow before 10-15 years or longer before you start accessing money from them.
IUL policies offer the potential for growth and tax-deferred access to cash value, making them an attractive investment vehicle for some individuals.
However, the policies can be complex and come with fees and charges that can eat into the cash value growth.
It is essential to understand the policy's potential for growth, fees and charges, and surrender charges before investing in an IUL policy.
Additionally, working with a financial advisor can help individuals determine if an IUL policy is right for their financial goals and risk tolerance.
White Swan is a digital broker that helps you protect your family and supplement your retirement with indexed life insurance and other types of life insurance solutions.