If you’re in the market for life insurance, the indexed universal life insurance offers another option for permanent life insurance. It differs from other types like term life insurance as it offers a lifelong policy which also has cash value.
In many ways, it’s similar to an IRA. The portion of your premium going to its cash value, which can earn interest, making it like an investment.
What Exactly Is Indexed Universal Life Insurance?
First, let’s look at permanent life insurance (namely universal life) to get a baseline about these products. You may be familiar with basic whole life insurance. It includes a death benefit and an interesting-earning cash value. If you keep it current, your beneficiaries will receive a guaranteed death benefit. Like term life insurance, you’ll pay a fixed premium through the life of the policy.
Second, whole life insurance is a safe option. Its cash value will increase over time. There is less flexibility with this type which makes it a stark departure from indexed universal life insurance. Whereas a whole life insurance policy is straightforward, there are many nuances with an indexed universal life insurance making it a better choice for the financially savvy individual.
Indexed universal life insurance, like other permanent life insurance, is more expensive than a term policy because it will pay out eventually. Thus, there should be a source of cash to fund the death benefits they pay. It’s simply a matter of statistics. The risk of death increases with age. The premiums of the different types of life insurance reflect this fact.
Under the Hood
Cash-value life insurance is complicated by its very nature. With indexed universal life insurance, a lot is going on under the hood. Part of the value of this type of insurance is the potential to earn interest. With this insurance, the value of a financial index such as a stock index chosen by your insurer is the basis for the interest you earn on your policy’s cash value. It is not a fixed rate.
Okay, so it may sound scary right there. However, your carrier isn’t sending you adrift. Your policy will likely include a minimum interest rate your cash value will receive. You’ll have a cushion if the carrier’s financial index isn’t doing so hot. But, it also applies to the other end of the scale. Along with the minimum, your policy may also have a cap on interest rates too.
Fees and Other Costs
A lot is riding on this financial index and your carrier’s ability to maintain your cash value. However, it’s worth noting you won’t lose money because of negative performance. There are charges associated with indexed universal life insurance and how it will affect its cash value. Your policy will undoubtedly include a myriad of policy fees and other miscellaneous costs.
And your cash value is the source of funding. Whether it’s penalties for withdrawals or interest on loans, these details can add up. This one of the primary disadvantages of dealing with a complex product like indexed universal life insurance. You need to be aware of all the factors which could affect your bottom line.
What Are the Advantages?
You may be thinking at this point why you’d even consider this insurance at all. Indexed universal life insurance does have some advantages making it worth a look. Remember, while you won’t lose money, you can make more cash when there are good returns on the financial index—even if there is a cap in place. This umbrella makes this type of insurance attractive.
The Tax Situation
The money you’ll contribute this insurance is post-tax dollars. There are tax advantages to having indexed universal life insurance. First, the money your cash value earns through its lifetime is tax deferred, not unlike an IRA. And, there are no limits on the amount it can make. Similar advantages extend to death benefits which are also tax-free.
You can allow your cash value to work for you even more with a tax-free loan. You may even be able to make withdrawals from the cash value of your policy. However, if it lapses, you will need to pay income tax on these monies. But the same applies to other investments where you make early withdrawals. Consider it as part of the entire package with getting this insurance.
Flexibility with Your Policy
Indexed universal life insurance offers another advantage regarding its flexibility. In this way, it also resembles other investments you may have.
You may be able to apply your cash value to premium payments, subject to approval, of course. You may also have the same flexibility with your death benefit. Depending on your policy, you may lower it whenever you choose.
There are a few caveats we should point out. If you’re making changes to your policy, there exists a possibility of changes to your income tax. Also, be aware if you increase your death benefit down the line, it could mean a medical exam. Seek out the advice of your insurance agent or tax advisor before making any changes.
Who Should Consider Indexed Life Insurance?
As you may guess by now, this insurance is not the optimal choice for everyone. Individuals familiar with the financial world will fare better at navigating through the complexities of pursuing it than someone with cursory knowledge. It’s what you don’t know which can end up costing you in the end. If you need permanent life insurance, it certainly offers something to consider.
There are several scenarios where it may work for you. If you want the assurance of a legacy for your children or grandchildren, you can get peace of mind with minimal risk—as long as you know what you’re doing. It’s another way to ensure your spouse has the security of personal income to manage short- and long-term expenses.
Our advice to you is to carefully consider your options. Make sure you’re receiving a realistic, albeit, conservative, at different returns. It’s impossible to predict what the market may do in the future. You should at least know what you can expect depending on how it plays out. And finally, make sure you understand the complete range of fees and extra expenses.
Let no room for unpleasant surprises. Remember the good points too. Your money will continue to grow on a tax-deferred basis like your 401(k). You can access it any age without IRS penalties for doing so. And don’t forget your option to get a loan. Indexed universal life insurance offers a reasonable option for supplementing your retirement income.
Our Final Stance
If you’re looking at indexed universal life insurance as an investment, it pays to consider all the factors affecting your bottom line. You’ll need to know what goes into stock earnings. Remember, you’re likely to be paid a set rate.
However, it won’t include stock dividends likely but rather just reflect the change in the index. The average dividend yield could play a larger role than you know.
You’ll also need to be aware of the policy’s participation rate. This percentage reflects the portion of the uptick in the stock index you’ll earn. It won’t be 100 percent. More likely, it’ll fall somewhere below the figure, perhaps in the 80 percent range.
While it may not seem like a lot, you should think of it in the long term. You’ll reap less than had you invested outright.