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Benefits of Indexed Universal Life (IUL) Insurance

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Indexed universal life (IUL) insurance combines life insurance coverage with the opportunity to accumulate cash value linked to the performance of a stock market index, such as the S&P 500. Investors looking for protection and investment growth may be considering an IUL policy. This type of policy also provides flexibility in premium payments, adjustable coverage options and a tax-advantaged way to grow savings. IUL insurance may be something to include as part of your financial strategy whether you are planning for retirement, protecting your family or seeking ways to diversify your investment portfolio

A financial advisor can help you determine what role life insurance could play in your financial or retirement plans.

What Is Indexed Universal Life Insurance (IUL)?

IUL insurance is a type of permanent life insurance that offers both a death benefit and a cash value component that grows based on the performance of a selected stock market index. Compared to traditional whole life insurance, IUL policies provide more flexibility and the potential for higher returns due to being linked to market indexes. 

IUL policyholders can allocate part of their premiums to a cash value account that earns interest based on the performance of a stock market index. The policyholder can choose from various indexes to determine how the cash value will grow, providing an opportunity for potentially higher returns compared to traditional fixed-interest life insurance policies.

While the cash value is linked to the performance of an index, the funds are not directly invested in the stock market. Instead, the insurance company credits interest to the cash value account based on index performance. The policies also offer a degree of protection against market downturns by including a guaranteed minimum interest rate.

One of the biggest pluses of IUL is the tax treatment. The cash value grows tax-deferred, meaning that policyholders do not pay taxes on the gains as long as they remain within the policy. In addition, the cash value can also be tapped via loans or withdrawals tax-free, as long as the withdrawals are done correctly. 

Key Features of Universal Life Insurance

Features of IUL policies make them useful for protecting your family while also diversifying your investment portfolio: 

Adjustable premiums and death benefit: Policyholders can adjust their premiums, within certain limits. This flexibility can be attractive to those with fluctuating incomes or who are looking to adjust their coverage over time.

The death benefit is also adjustable. Policyholders can increase or decrease the coverage amount as needed. This can be helpful for those who may need more coverage at certain life stages, such as when raising a family, and less coverage as financial responsibilities decrease in retirement.

Cash value: The cash value grows tax-deferred and can be used for various financial needs, such as supplementing retirement income, funding education expenses or providing emergency funds. Policyholders can tap the cash value via or withdrawals, typically without incurring taxes as long as the policy remains active and withdrawals are done according to the rules. 

How Does an IUL Policy Work?

A woman comparing life insurance policies.

An IUL policy combines the death benefit of life insurance with investment opportunities. Policyholders pay premiums that more than cover the cost of the insurance. The excess contributes to the policy’s cash value. 

In addition to increasing as premiums are paid, the cash value can grow based on the performance of a chosen stock market index. There is also usually a minimum return, allowing policyholders to potentially earn higher returns while maintaining a level of protection against market downturns.

Benefits of an IUL Policy

  • Flexibility: IUL policies offer flexible premiums and death benefits, so policyholders can adjust their coverage as needed. This flexibility makes it easier to adapt the policy to changing financial situations and life stages, ensuring that it continues to meet the policyholder’s needs over time.
  • Tax advantages: The cash value in an IUL policy grows tax-deferred, and loans or withdrawals can be taken tax-free under the right circumstances. This tax treatment can provides a significant advantage for IUL policies compared to other investments. 
  • Potential for higher returns: Because the cash value is linked to the performance of a stock market index that can vary, IUL policies offer potential for higher returns than fixed-interest life insurance policies. 

Drawbacks of an IUL Policy

  • Complexity: IUL policies can be complex, with various features and options that may be difficult to understand. Policyholders need to be informed about how the policy works, including the factors that affect cash value growth and the potential for fees and charges that can impact overall returns.
  • Market risk: While IUL policies offer growth potential linked to stock market indexes, they also expose policyholders to some market risk. Although most policies include a guaranteed minimum interest rate, poor market performance can still limit cash value growth, potentially affecting the policy’s overall value.
  • Fees and charges: IUL policies often come with fees and charges that can impact cash value growth. These may include administrative fees, cost of insurance charges and surrender charges. Especially in the early years of owning an IUL policy, fees and charges may limit growth of the cash value account. For this reason, IUL policies are not likely to be successful short-term investments. Understanding these costs is important for policyholders to ensure that the policy aligns with their financial goals and expectations.

What Should I Consider When Choosing an IUL Policy?

When choosing an IUL policy, consider factors such as the policy’s fees and charges, the index options available for cash value growth and the flexibility of premium payments and death benefits. It’s also important to evaluate the insurance company’s reputation and financial stability, as this can impact the policy’s long-term performance. Consulting with a financial advisor can provide valuable insights and help you select an IUL policy that aligns with your financial goals and risk tolerance.

Bottom Line

A woman researching investment opportunities with life insurance.

IUL insurance offers a combination of life insurance protection and investment opportunities. Compared to other cash-value policies, IUL can provide added flexibility and potential for higher returns along with tax advantages. However, IUL policies are also complex, which can make it challenging for investors to choose wisely. And they commonly come with sizable fees and other costs, which can limit their usefulness for investors working with shorter time horizons.

Financial Planning Tips

  • A financial advisor can help you create a personalized financial plan that includes life insurance. 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 asset allocation calculator to help you apportion your investment portfolio to suit your level of risk tolerance.

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