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Asian couple buying life insuranceAccording to LIMRA’s Insurance Barometer Study and the Insurance Information Institute, 54% of people during 2020 in the U.S. received coverage through some type of life insurance. You’ve likely considered it as part of your own financial plan, especially if want to ensure dependents will be taken care of after you die. But life insurance can benefit you while you’re still alive as well. Indexed universal life insurance offers policyholders both life insurance and an avenue for asset growth. Here are the indexed universal life insurance pros and cons and how it may, or may not, work into your overall financial strategy.

Need a financial advisor to help you pick the right kind of life insurance? Use the SmartAsset matching tool to quickly find several in your area.

What Is Indexed Universal Life Insurance?

Indexed universal life (IUL) insurance is a form of permanent life insurance under the umbrella of universal life insurance. When you purchase this kind of policy, you pay a premium that covers two costs: a death benefit and a cash value component. The cash value grows by building interest, similar to a savings account.

However, interest rates are often low, leaving the rate of inflation outpacing the cost of the policy.

An index universal life insurance policy tries to ensure your policy is profitable by investing the cash value into a fund. This fund tracks, or mirrors, an index on the stock market. So, as an index fund, its growth and success depend on the index tied to it. This may vary across the years.

Pros of Indexed Universal Life Insurance

IUL insurance policies include several features that investors may find appealing. Some of them include:

Flexibility

Universal life insurance policies promise their holders flexibility. So, IUL insurance also carries the same perk. You can adjust your premium and death benefit as you see fit. Likewise, an person may also change the amount of coverage or contributions they make during the policy’s term.

But that’s not all. The policy promises flexibility with its withdrawals, too. Policy holders aren’t penalized for making withdrawals prior to retirement and can take out loans against the cash value built up in their IUL insurance policy.

Tax-Advantaged Growth

You pay your insurance premiums with after-tax dollars. That gives IUL insurance policies a leg up over other forms of insurance policies and savings vehicles.

The cash value builds on a tax-deferred status, allowing for potential gains. Policy holders may even find that IUL insurance gains higher than what similar products can provide, such as traditional universal life.

Also, a number of features go tax-free, including the beneficiary death benefit, withdrawals and loans taken out against the cash value component.

Index-Linked Growth

An IUL insurance policy tracks alongside an index. If the index grows at a positive and favorable rate, then so will your cash value. It might even grow faster than a cash value offered through a traditional universal life or whole life policy.

Policyholders also benefit from a crediting floor, which protects the existing cash value from significant loss when the market plummets. Of course, you’ll still experience applicable policy expenses, though.

Cons of Indexed Universal Life Insurance

Like any type of financial asset, IUL insurance policies include their own variety of drawbacks. Some that may impact your decision include:

Risks

Pair of hands forming a circle around the silhouette

And IUL is tied to an equities index, and while that comes with potential benefits, it’s not risk-free. The risk stems from possible market fluctuations. So, if the index performs poorly, the policy may as well. Compared to a standard universal life insurance policy, IUL insurance poses a greater risk for loss. Although, it still is less risky than a variable life insurance policy, which actually invests in the stock market.

Price Increases

When you purchase term life insurance, the price gets locked in for the length of the policy. In contrast, whole life insurance, like IUL insurance, varies in cost depending on a few factors.

Age plays the biggest part in determining your policy price, though. As you grow older, you become more susceptible to illness, injury and more. For the insurance company, that means older individuals are riskier to insure than younger ones. So, you’ll likely see dramatic price increases along with a policy owner’s age. In particular, you should expect price spikes after age 50.

Additional Costs and Fees

An IUL insurance policy may come with unexpected costs. Fees tend to be added on at the start and built into the crediting rate calculations. Some of the potential charges include a premium expense charge, commission, insurance costs, administrative expenses and surrender charges.

Also, if you pass with outstanding loans taken out against the policy, then the funds may be liable for income tax. Additionally, gains from a canceled policy also become taxable.

Limited Upside Index Exposure

An IUL exposes you to some index movements but not to the full extent of any gains in the relevant index. There are several reasons for this.

To start, your policy may implement a cap. This essentially puts a limit on the gains you can earn through your policy. So, if the market rises to 10% but you have a cap of 8%, the policy will stay at the latter value.

Additionally, spreads and participation rates can also reduce your gains. Moreover, a policy may use more than one method to limit your growth.

Is Indexed Universal Life Insurance Right for You?

Permanent life insurance can work for many people who want consistent coverage throughout their life and hope to build a cash account. In addition, the growth offered through an IUL policy promises some loss protection. If these traits appeal to you, then it may be worth investigating. But every financial move comes with potential advantages and risks. Likewise, an IUL insurance policy may only work for certain policyholders.

If you’re new to investing, though, there are better options to start with out there. An IRA or 401(k) are probably more suitable to help you prepare for retirement and build savings – especially if you’re young. An IUL comes with a cap that limits the policy’s cash value growth and doesn’t pay dividends. Thus, you will not benefit financially in the same way you would with actual investments, especially equities.

However, for those who want to include IUL insurance among their financial assets, it does promise perks. You can still realize profits without facing capital gains tax and have a death benefit waiting for your loved ones in the future.

Takeaway

Mother and babyIndexed universal life insurance offers policyholders a way to own part of an index fund and grow their cash value. However, it is subject to some risk, and there is no guarantee that the funds will grow. Before pursuing any life insurance policy, take stock of the needs you must meet in your own life. Consider the type of funds you want for your golden years and the dependents you have to provide for.

Life Insurance Tips

  • With the potential for growth and tax advantages, you might find yourself considering an IUL policy. Or, you may want to research other options to help protect your wellbeing. In that case, check out these life insurance quotes for a policy that suits your needs.
  • An IUL insurance policy may work for some policyholders and investors. But its risks and costs mean it won’t fit into every financial plan. If you’re interested in exploring how an IUL policy could work for you, consider speaking with a financial advisor. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

Photo credit: ©iStock.com/kazuma seki, ©iStock.com/scyther5, ©iStock.com/FatCamera

Ashley Kilroy Ashley Chorpenning is an experienced financial writer currently serving as an investment and insurance expert at SmartAsset. In addition to being a contributing writer at SmartAsset, she writes for solo entrepreneurs as well as for Fortune 500 companies. Ashley is a finance graduate of the University of Cincinnati. When she isn’t helping people understand their finances, you may find Ashley cage diving with great whites or on safari in South Africa.
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