INDEXED UNIVERSAL LIFE (IUL)
We’d like to state right up front that one primary con to getting indexed universal life vs term life is price. If, for example, you are a person with less than $50 in disposable income after all your mandatory bills are paid, but still need life insurance protection, level term life insurance might be the better option.
However, if you are part of the majority of the country that is looking for protection, stability, growth, and tax advantages for your retirement – keep reading. An indexed universal life insurance policy may be exactly what you need to secure your financial future. And even if you think that you are probably not the ideal candidate, you owe it to yourself to know the facts so you can see for yourself.
10 Top Pros of Indexed Universal Life Insurance
#1) Death Benefit
Above all else on the list of indexed universal life insurance pros is the Death Benefit. IUL is a permanent life insurance product and ultimately the thing you are insuring (your life) is of utmost importance. Hopefully we can all agree on this point. Money will never be able to replace the loss of a loved one, but avoiding the double-whammy of a family death and massive financial hardship is significant.
I still remember the day my policy went into effect. The joy of knowing that my family would be covered if something happened to me was a tremendous feeling. I was actually amazed that I could get such a large policy for such a great price.
I think many people wander around ignorant of the need for life insurance policy, but once they are educated and see their own need, there is usually a tremendous sense of urgency that is only relieved by getting covered.
An additional benefit that many people are taking advantage of is a life insurance with long term care combination policy. Also known as hybrid life and long term care, these policies provide all the benefits inherent in life insurance, but with the additional benefit of long term care protection.
#2) Cash Accumulation
If the number one benefit for an IUL is the death benefit, the number two reason could probably be considered #1 for those that live long enough to enjoy retirement – cash value accumulation. Your cash value grows according to either a Fixed Account Value or Index Participation Rate. There are pros and cons to each crediting method.
An IUL is a permanent life insurance policy that has a cash value (CV) and allows for cash accumulation inside the policy. This cash value grows over time as the individual pays into the policy. The cash value can always be accessed and used as you see fit.
In addition, policy withdrawals are tax-free, up to the amount of premiums paid, because the premiums were paid in after-tax dollars.
And don’t forget that you can also access the growth of your account tax-free, by taking a policy loan (sometimes called a swap loan) against your cash value.
For those with a lot of extra cash to invest each year, there is a limit to the amount you can pay into the policy (typically a percentage of the total policy value). Companies want to make sure you remain below the point where the IRS would consider the insurance a fully taxable modified endowment contract or MEC. So keep that in mind if you’re thinking this could be a tax shelter for your tremendous horde of cash in the basement.
#3) Gains Locked In
Another great pro of Indexed Universal Life Insurance is that each year the gains are locked in or captured. In other words, every year your gain will be secured along with your previous cash value total. Each year’s credited interest is locked in on the Index Crediting Date. From there, the company sets a new starting point called the “annual reset”. All interest credited during the prior period is locked in and will not be taken away due to negative index performance.
To fully understand this let’s look at your money if it were not in an IUL, but instead invested in the market.
Just as there are indexed universal life insurance pros and cons, there are pros and cons to being invested in the market. The pro to investing in the market is that you can reap any and all upside growth, and even without selling you can benefit from dividends that companies issue to stock holders.
The con to investing in the market is that you can also reap any and all negative returns, and negative returns can wipe out all previous gains combined. In other words, you can lose all your money. It may be unlikely, but it’s possible.
So what about the IUL?
Within an IUL your insurance company does not invest your cash value in the stock market for you. Instead they give you a return based on the market index performance, called theIndex Participation Rate. In addition the return has some limits.
The policy will spell out the limits, but currently many of the IUL providers are setting limits in the low teens for the maximum, and around 1% for the minimum.
This means that you’ll never get more than the Index Cap Rate maximum of 13% (or whatever the max limit is for your policy) when the market index exceeds that amount. It also means that you’ll still get 1% when the market index drops below zero and has a negative year.
Keep in mind that it also means that you will not get any dividends from your investments, like you would if you were actually investing in the market. But I would argue that it is a small price to pay for the peace of knowing that each year my gains are locked-in and will not go away.
Recently I’ve heard of some rather shady policies being written that allowed for the minimum to be attributed over a period of years, instead of annually. So in essence you could have two positive years, and then two negative years, but they would still give you the “average” of at least 1% over a total of 4 years. I’ve never seen a policy like this, and I suspect that they are very uncommon if they’re out there at all. Regardless, you should always work with a reputable company and ask questions when applying. I’ve never written a policy with anything other than an annual guarantee.
#4) Market Loss Protection
One of the most discussed indexed universal life insurance pros is the protection against market loss. As mentioned earlier, the locked-in gains are fantastic, but those can only be accomplished by protecting against a market loss. So the two provisions work hand in hand. The insurance company will provide you with a guaranteed minimum amount that will be attributed to your cash value. Typically the guarantee is around 1% and is attributed annually.
What this means for your cash value is that when there is a horrible year in the market, or even just a year in which the markets drop below zero, the amount that will be attributed to your cash value is the guaranteed minimum, called your Index Floor Rate. In a market that is volatile or significantly bearish (down) the minimum guarantee protects your cash value and keeps you on track toward your financial goals.
Now I’m sure there are situations in which an insurance company went bankrupt and a guarantee wasn’t met, but those situations are the exception rather than the rule. And state governments take over when these situations arise so it’s not like you will lose everything. In fact you are likely to find yourself doing just fine but with a different insurance provider.
#5) No Mandatory Distribution
When you get ready to retire, there is no mandatory distribution in an IUL. If you have an IRA or 401(k) you’ll have to start taking distributions (withdrawals) from your account sometime after you turn 70.
I’m sure you know already, but the reason for this mandatory withdrawal is because the IRS can’t tax that money until you start to take withdrawals. That account is tax-deferred, not tax-exempt.
This may not seem like a big deal to you when you read it, but if you’re trying to build your retirement account while you or your spouse is still working, these mandatory distributions can seriously slow your progress.
Indexed Universal Life has no such mandatory distribution requirement. If your spouse is working and you are retired, you can live off the employment income and let your cash value grow and grow without taking out any money. (If you have a 401(k) and you are still working after reaching the age limit, you can delay the distributions, but only until you stop working, then it becomes mandatory)
#6) Upside Growth Potential
The Indexed Universal Life policy has serious upside growth potential (consider an IUL for estate planning when funding an irrevocable life insurance trust).
This is a big deal because it means that you don’t have to be in really risky stocks in order to get some of the benefit of a great bull (up) market. If the market index that your policy is tracking increases 10% in a given year your account will be credited around 10%. If the market index increases 20%, your account will be credited with the max or cap, which is currently around 13% for most policies.
Back in the 1990’s when the stock markets were going crazy and everything seemed to be making a return of 10%, 20%, and even higher, the insurance companies had to provide a product that would allow for some upside gain in great years. The IUL was the answer and the cap rate came into being. The additional % that the market index returns above the cap is used to make up for the years in which the company has to cover the losses of a negative year and give the minimum guarantee.
All in all it seems like a fair trade-off for those of us that aren’t looking to win the lottery in one year, but also want to protect against giant sell-off years.
Further, although purist of the concept might argue on dividend paying whole life insurance works, using an IUL to practice the infinite banking concept can further catapult your total upside growth. If your not familiar with this concept please take a moment and get familiar. It can be life altering in the hands of the right person.
Indexed Universal Life is a tax-deferred policy. Similar to that of a 401(k) or an IRA, but different in many significant ways (some of which I’ve already mentioned above).
If you choose to build up your cash value in an IUL and use the protection during your working years, the policy will act much like any other tax-deferred product. The cash value will grow and you will not pay tax on the growth in the cash value. If you happen to close the account (not recommended) or take withdrawals instead of policy loans, you will pay taxes on the growth.
However, unlike the IRA and 401(k) accounts, there is a way to access the cash value tax-free without incurring any penalties. In addition, you can always withdraw from your cash value up the amount of the premiums paid in without being taxed because those premiums were paid in after-tax dollars.
#8) Access Cash Value
With an IUL you can access your cash value any time you want (during business hours of course). Or more precisely, you can access your cash value at any age you want. You do not have to wait for some pre-determined required age to have access to your account.
Many tax-deferred retirement accounts have an age restriction of 59 1/2 before you can access the money. If you withdraw ahead of time there are penalties and restrictions.
Another indexed universal life insurance pros is that you can access your cash value at any age without restriction. I don’t know about you, but I prefer to have zero limits on accessing my own cash. With an IRA you do have some stipulations for emergencies, and age distributions, but even so they seem very limiting comparatively to an IUL.
And another thing to be aware of is your policy loan does not have to be paid back. This provides maximum flexibility. Loan interest is charged in arrears and unpaid interest is added to your total loan balance.
#9) Social Security Taxation
You don’t have to worry about Indexed Universal Life impacting your Social Security taxation. Many people don’t know this, but the money you make from Social Security in retirement, may be taxed as income. The income from an IRA might just put you over the limit (currently $32k if filing jointly, or $25k if filing as an individual) and therefore cause your social security to be taxable.
Let’s say for example you get $24k a year from Social Security, and you take another $40k from your IRA each year. If your house is paid off and you don’t have any other write-offs, you may find yourself in a situation in which the Social Security benefits are taxable, and you’re in a higher tax bracket.
If instead of an IRA you had an IUL policy loan for 40k per year, your taxable income would be zero because you would be under the base limit. For an individual or family that is living on less than $80k per year, you may find that your annual tax savings are in excess of $10k. That’s a big deal. For those making more, your savings would be even greater. That’s a bigger deal.
#10) Disability Rider
The final benefit of our indexed universal life insurance pros and cons list is one that is actually an additional life insurance rider on most policies – the disability rider. The disability rider will continue to pay the premiums, and keep the policy in effect, even if you are permanently disabled.
In some cases, the rider will actually pay the amount you were currently paying at the time of disability (so if you were over-funding, the rider would match). Usually the additional amount of premium to add this rider is extremely affordable considering the possible benefit.
With this rider, you can become permanently disabled and the insurance company will start paying your premiums for you. Just think about that for a minute, and tell me if you know of any other retirement account out there that will do something similar? I couldn’t think of any.
Indexed Universal Life Insurance Cons
The first indexed universal life con is price.
There are no two ways around it, you will pay more for indexed universal life than you will with term life. At least initially. Overtime you will accrue cash value in your policy that should make your policy more efficient.
What do I mean by efficient?
As your policy’s cash value grows, your net amount of risk goes down. So as your total cost of insurance increases as you age, the company is only looking at the part of your policy that represents risk to the company.
So this means that an IUL policy that has ever increasing cash value has a lower net amount of risk. And this lower net amount of risk keeps your premiums in check.
Another indexed universal life con would be the amount of care you have to take in maintaining your policy is going to be greater than with whole life insurance or term life.
Level term life is easy to maintain because you pay a fixed premium. Now when the initial term expires all best are off. But initially, the fixed premiums make term life simple.
Whole life is also easier to maintain because of the guarantees offered, particularly the guaranteed fixed premiums. You know what you have to pay and it takes a lot of variables out of the equation.
With an IUL, your premium can rise or fall depending on how you fund your policy and how your policy performs. It may be that you find yourself not having to make premiums for a time or you may find that you have to make huge premiums to keep the policy from lapsing.
Now that is the extreme scenario, but the fact remains you have to be more diligent with indexed universal life or risk it blowing up on you.
As you can see, an Indexed Universal Life Insurance policy offers some great benefits. I already mentioned that you might not be the right candidate if you happen to meet certain rare criteria, but if you happen to be in the majority, or just want to talk about what your options might be, please give TermLife2Go a call and we’ll present you with all the options, so you can make an informed choice on your own.