Equity-indexed life insurance is a type of permanent life insurance policy that combines elements of traditional life insurance with investment opportunities. While more expensive than simple term insurance, it allows policyholders to build cash value in a separate account. With an equity-indexed life, the cash value can grow tax-free by earning a return that tracks a stock market. Policyholders can tap the cash value with loans and withdrawals. Sit down with a financial advisor to decide how life insurance can be used in your financial plan.
Equity-Indexed Life Basics
Like other types of life insurance coverage, an equity-indexed life policy provides a death benefit to beneficiaries upon the insured’s death. In exchange for this benefit, the policyholder pays a premium to the insurance company. Unlike term insurance, the premium for an equity-indexed life policy is more than the cost of providing the death benefit. A portion of this excess is deposited into a cash value account.
The value of the cash account can increase over time. With an equity-indexed life policy, the insurance company ties the cash value to a stock market index such as the S&P 500.
Other types of insurance, such as traditional whole life and universal life, also can be used to build cash value. However, with these types cash value generally grows at a fixed rate. Because its growth rate is tied to a stock market index, the equity-indexed life policy offers the opportunity to get more growth than other cash value policies.
How Equity-Indexed Life Insurance Works
Applying for an equity-indexed life policy resembles applying for any life insurance. It may involve a medical exam to establish that you are eligible for life insurance.
Once approved, you’ll make premium payments, often monthly, to keep the policy active. After your death, the beneficiaries you named receive a lump sum. Insurance death benefits are generally tax-free and also avoid probate, making insurance a useful tool in estate planning.
As you pay the premiums, a portion of the amount in excess of the cost to provide the death benefit gets deposited in the cash value account. This cash value can grow based on the performance of the chosen equity index.
Any growth in the cash value account is free of income taxes. And you’ll generally be protected against losing money even in a market downturn by a guaranteed minimum interest rate. If the market does well, on the other hand, the policy terms may limit your gains with a cap.
The policyholder can withdraw or borrow against the cash value, once the contributions from the premiums and any earnings accumulate to a certain amount. Loans and withdrawals may, however, reduce the death benefit.
Equity-Indexed Life Insurance Pros and Cons
Equity-indexed life insurance offers some specific advantages compared to many other approaches to insurance and investment. However, it also has some notable downsides.
Pros of equity-indexed life include the potential for higher returns compared to other types of insurance such as traditional whole life, which generally has a set interest rate. In addition to the possibility of better earnings, equity-indexed life policies also have a safety net in the guaranteed minimum interest rate.
In addition, equity-indexed life has some significant tax advantages. The death benefit from the insurance as well as the earnings on the cash value account are both generally tax-free. And having the ability to tap the accumulated cash value for loans and withdrawals offers policyholders useful flexibility.
Cons of equity-indexed life insurance include the cap that most policies place on how much you can earn. And, while there is a guaranteed minimum return, it may be less than you could earn with another investment. Equity-indexed life is also more expensive as a rule than term life insurance. That is because part of the premium goes to fund the cash value account and also because of added fees.
Equity-indexed life insurance is a complicated financial product that combines features of life insurance and investments. Using it effectively requires a good understanding of both insurance and investment principles. While it’s more costly than term insurance, the higher premiums go to fund a cash-value account that can grow. The growth rate for this account is set by tracking a stock market index, but it may not perfectly track market returns. The cash value account may be protected by a floor limiting how low the rate of return can go, which can be helpful in a down market. However, it may also have a cap limiting the upside.
Tips on Insurance
- A financial advisor can help you make informed decisions about insurance, investing and other aspects of your personal financial life. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Use SmartAsset’s Life Insurance Quotes tool to find what you’ll pay for the coverage you need.
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