Indexed Universal Life Insurance

Written by Jeff Root

Life insurance comes in a lot of shapes and forms. The various types of life insurance policies are usually divided into two main categories: term life insurance and permanent life insurance.

Term life insurance coverage lasts a given period of time, between 10 and 30 years. After this, your coverage expires and you must find more coverage. Term life insurance policies can be converted into permanent life policies with the help of the term conversion rider which is offered by most insurers.

Permanent life insurance is coverage that lasts for your entire life or until you reach the maximum age under the terms of the policy. Typically, this maximum policy age is 95, 101, or 121 years of age. On top of the lifelong coverage they offer, these types of life policies offer cash value accumulation over time, which is grown from the premiums you pay into the policy and able to be borrowed against on a tax-free basis.

Cash value can be accumulated in many ways, and as a result, there are many forms of permanent life insurance. One of these types is the indexed universal life policy.

What is Indexed Universal Life Insurance?

An indexed Universal life insurance policy is a form of permanent life insurance that has a cash value benefit derived from the market performance. The cash value of indexed policies grows based on the performance of a market index such as the DJIA or S&P 500.

Indexed universal life insurance is literally the combination of an indexed life and universal life policy.

Cash Value Accumulation – Indexed

Indexed life insurance policies grow in relation to a market index. Can include any number of market indices, depending on what the company offers.

Flexibility of Premiums, Death Benefit – Universal

Universal life insurance policies allow policyholders to vary how they pay their premiums, what their death benefit is, and as a result, how much cash value they accumulate with their policy. This works like this:

Say you want to pay less in premiums for the next few months because you are moving and expect extra expenses.  You change your monthly premium from $600 to $100 and use your cash value you have already accumulated to pay for the premiums for those months.  As a result, there is less money going into your account, and less is invested in the market. Over time, this can be used to gain far more cash value, provided you pay in extra money in good times.

On top of this, you can change your death benefit as needed, which will also change your premiums.

Combining Them – Indexed Universal

Indexed universal life insurance policies take the security of indexed policies when it comes to cash value accumulation and hedging against risk, and combine it with the flexibility of universal life insurance when it comes to the way you pay premiums, receive death benefits, and accumulate cash value. This makes for a very user friendly indexed fund combined with the financial protection of life insurance.

How Does Cash Value Accumulation Work on Indexed Universal Life Insurance Policies?

To protect policyholders, most indexed universal policies have a minimum amount that you can earn to protect you against serious losses in the event of a market downturn. This minimum return on indexed universal policies is usually set to 0%.

The upside of your cash value gains depends entirely on the market performance. In good years, like we have seen over the last decade, indices can grow dramatically. In down years, you are protected by the minimum 0% gain.

Because the life insurance company is taking the risk of investing your premiums combined with a large collection of others’ premiums, some companies do have a maximum amount of returns that you can make on indexed universal life policies.

How are Funds Allocated with Indexed Universal Life Insurance Policies? 

So how is interest calculated in credited? First you pay your premium for the policy. That premium goes into a basic interest strategy. It is this basic interest strategy which hold on to the premiums in order to fund one year of your insurance costs and your policy charges. From that money the remaining premiums are put into different segments.

The segments can be a combination of fixed strategies or indexed strategies which you choose for a specific amount of time. That amount of time is referred to as a segment term. The segment term ranges between 1 year, 5 years, or six years depending on the strategy chosen. Once that strategy is put into effect the money cannot be redirected until that segment term is over. Once that segment term ends the money is placed back into the basic interest strategy. Then, new premiums are placed into another basic interest strategy and that process continues once again.

An index strategy Works based on the participation rate

If for example the S&P 500 increased by 10% from the beginning of a segment term until the end and the participation rate of that policy with 85%, the amount of Interest credited back to the policy is 8.5% because that equals 10%, the total performance, times the participation rate of 85%.

Remember that most companies also have a cap or a limit on how much you can make.  The limit you have is going to be based on the strategy and the limit can actually be increased at the beginning of every segment term.

For example you might have a cap rate of 12.5%. The S&P 500 increased by 17% during your segment term with a participation rate of 100%. If that is the case the amount of Interest return to your policy is 12.5% because at a participation rate of 100% the interest you receive has to be equal to or lesser than the cap which is 12.5%.

Borrowing Against Cash Value with Indexed Universal Life Insurance

This is the same thing. An indexed universal life insurance policy is a form of permanent life insurance or whole life insurance. Some companies might offer it specifically under what is called their whole life insurance policies as opposed to their term policies. It’s really a matter of semantics.

This type of policy gives you tax-free death benefits because the income earned is not taxable unless you cancel your policy prematurely. Moreover, the policy allows you to take out a loan against your cash value if you need money to supplement your retirement. You can take out a fixed loan against the cash value of the policy you have and for this you will be charged a fixed rate of interest until you pay it back.

Typically speaking the amount of the loan is deducted from your interest crediting segment and therefore is not considered earned interest so you don’t have to pay taxes.You can also take out what are called premium loans which are a form of fixed loan typically only available to policyholders who have had a policy in effect for a specific amount of time.

A premium loan typically won’t charge interest. Also with this type of policy you can take out what is called a variable Loan in relation to the amount of cash value you have. These are going to be based off of a national loan rate and the amount of the loan will remain in your segment for the purposes of interest crediting and it will accrue interest until you pay it back in your policy.

Indexed Universal Life Insurance vs. Whole Life vs. Variable Life vs. Guaranteed Universal

To understand if indexed universal life is the best life insurance policy for you, it is important to understand how it compares to other types of permanent life policies.

Policy Indexed Universal Whole Life Guaranteed Universal Variable Universal
Premiums
  • Variable premiums over the life of the policy
  • Use cash value to cover premiums you can’t afford
  • Pay extra premiums to boost cash value growth
  • Level premiums through the life of the policy
  • Cannot change the amount you pay each month
  • Term life insurance that is paid annually or monthly
  • Lack of payment of policy premiums can result in policy cancellation
  • Variable premiums based on what you can afford
  • Use cash value to cover premiums as needed
  • Pay excess premiums to increase cash value growth
Death Benefit
  • Variable Death benefit depending on cash value + face amount
  • Guaranteed and Level Death benefit
  • Guaranteed Death Benefit as long as your premiums are paid
  • Policies cover you to a maximum age which is usually 90, 95, 100, 105, 110, or 121
  • Variable death benefit that you can raise or lower
  • Guaranteed death benefit as long as premiums are paid
Cost
  • Expensive, more so than whole life insurance because of the additional flexibility of the policy
  • Far more expensive than term life insurance
  • Very cheap for permanent life coverage, comparable to term life insurance rates
  • More expensive than whole life insurance
Risk
  • Medium risk
  • Low risk
  • Very low risk
  • High risk
Cash Value Accumulation
  • Cash value is tied to an index fund with minimum gains of 0% and maximum gains as well
  • Cash value is accumulated at a guaranteed rate each year, no matter how the market performs
  • Very low, but guaranteed cash value accumulation which can be adjusted with policy premiums based on company
  • Cash value is grown through investments in various mutual funds, usually with minimum gains

As you can see, based on it’s performance against the other types of permanent life insurance policies, indexed universal offers quite a bit of control in terms of your premiums, death benefits, and cash value accumulation. The cash value is grown at a modest rate, and risk is very low. You also have the option with indexed universal of lowering and even not paying your premiums as long as your cash value can cover the cost of them.

The Pros and Cons

Pros 

1. Tax Free Cash Value Accumulation You Can Borrow Against

The cash value you gain is tax free and perhaps most attractive to many investors, it does not expose itself to any risk in the event of a market downturn. However, this can be said about any type of permanent life insurance policy

2. Stable and Safe Level of Growth to Risk 

You also have a higher return potential with this type of policy because you can gain a better exposure to the performance of an index without losing a lot of money, and many whole life insurance policies give you a much smaller interest rate which is not guaranteed like it is with an indexed policy.

3. No Capital Gains on Indexed Fund Growth

Finally, you don’t have to pay capital gains on the cash value unless you decide to abandon your life insurance policy before it matures.

4. Flexible Premiums, Cash Value, and Death Benefit 

As we said earlier, the premiums are flexible, along with the death benefits and your cash value growth. Combine it with the lower risk associated with index funds and the minimum gain of 0% and you have a very safe permanent life policy in terms of risk and in terms of the protection it offers for the various stages of your life.

Cons

1. Cap on Annual Cash Value Accumulation

Unfortunately, they also have a cap to prevent you from gaining too much.  Each company sets a different standard but they all have a limit on how much you can make regardless of how well the market or index performed. If, for example, you establish a policy over time and the market does not perform well you might end up paying very high premiums without getting any cash value out of it.

2. No Guaranteed or Level Premiums

There are also no guarantees. Whole life insurance policies typically come with a guaranteed interest rate which means that you are guaranteed to make something and something is always better than nothing. But with an indexed universal life insurance policy, the premiums and the returns are going to vary based on market performance and there is no guaranteed interest rate.

Who is Indexed Universal Life Insurance Best for? 

This type of life insurance is best for: 

  • People who want cash value growth that is connected to an index, with no down side
  • Those who want flexible premiums
  • People interested in flexible death benefits
  • Someone who is willing and able to pay attention to their premiums and their index

People should not consider indexed universal if: 

  • They are looking to make steady gains each year
  • They are looking to maximize their potential cash value gains from their permanent life insurance policy
  • They are looking for the most affordable whole life insurance policy for the return
  • They do not have the time to manage their premiums, or do not want to think about constantly changing premiums

Companies That Offer Index Universal Life Insurance

There are quite a few companies on the market that offer indexed universal life insurance products, but these are some of the best:

Company A.M.Best Customer Reviews
American National A 4.3 / 5
Mutual of Omaha A+ 4.1 / 5
North American A+ 4.0 / 5

Where to Find the Best Indexed Universal Life Insurance Coverage

We help our clients to find the best life insurance coverage form the best life insurance companies on the market.

Our agents are independent, meaning they are not held captive by a few companies, but work for you and can offer a myriad of life insurance options to you based on your needs and wants.

Give us a call today to learn more about where you can find the best indexed universal coverage, and find out if it is the best policy for you and your family.

Or get started online with our free quoting engine, for quick and easy indexed universal life insurance quotes.

About Best Life Insurance Companies
About Best Life Insurance Companies

We work with individuals across the nation to secure the best life insurance rates.

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