Indexed universal life insurance is a type of permanent life insurance that offers different benefits to policyholders. Here is what you need to know!
Traditionally, life insurance has been one of those assets someone might hold but hope they never have to use. Often crafted to protect from the worst-case scenario, it’s most known for the death benefit it can offer heirs in the event of untimely death, providing a payout that has the potential to ease both financial and emotional tension. Modern life insurance options, however, can come with different features depending on the type of policy you purchase. Because September is Life Insurance Awareness Month, we thought it would be the perfect time to go over one of those options: indexed universal life (IUL) insurance.
NOTE: When reading this information, it’s important to remember that life insurance may require medical underwriting and sometimes policies can be denied. In general, the younger and healthier you are, the lower the cost of insurance.
- The Classic Death Benefit
The classic benefit of every different type of life insurance policy, including IUL, is the death benefit, which is typically paid out to the policy’s named beneficiaries tax- and probate-free in the event of the policyholder’s death. This can give your heirs a nice sum of money to cover things like burial and funeral costs, outstanding debt, and living expenses. It can be difficult to lose a provider, and a life insurance death benefit can ease some of that burden.
- Permanent Coverage
IUL policies offer permanence, which can make them a viable option for all ages. Unlike term life insurance, where the death benefit expires when the policy expires—typically in 20 or 30 years—an indexed universal life policy is a permanent policy that offers your beneficiaries a death benefit as long as premiums are paid and the policy is in force. While term policies can offer relatively affordable premiums for young, healthy policyholders, an IUL can lock in and guarantee coverage even if the policyholder develops a condition that would make them uninsurable later.
Increasingly popular [1], indexed life policies are sometimes purchased by healthy seniors as a way to transfer tax-advantaged wealth as part of their estate plan, or seniors may elect to purchase a policy which has long-term care benefits either built in or added as an optional rider to an IUL policy.
- Flexible Premiums
One of the key differentiators between whole life and universal life is flexible premiums. IUL policies allow policyholders to determine the monthly premiums they pay based on their desired death benefit and/or cash value in the policy. For instance, if your need for a high death benefit is not as great as it once was, you can pay lower premiums while still keeping your policy in force. Furthermore, the cash value portion of the policy can also be accessed to pay premiums, whether that’s by choice or by the policyholder’s inability to pay monthly premiums. On the other hand, policyholders with the funds to increase premiums to increase coverage can do so, potentially meaning a greater death benefit and a greater cash value.
- Accessible Cash Value Portion
Permanent life insurance policies like whole life and universal life offer a cash value portion that is funded by the policy’s premiums. Because the policy’s premiums are paid with post-tax dollars, that cash value is accessible to the policyholder for any reason as a tax-free loan, potentially making IUL a useful source of income for retirement, postsecondary education, a downpayment for a home, or any other major expense. Granted, borrowing from the cash value of a policy does accrue interest per policy terms; however, the cash value in an indexed universal policy also continues to be credited interest as if the borrowed amount is still there, again based on the contract terms. That gives the cash value a chance to keep pace with, or even outpace, the amount the policyholder owes in interest. Furthermore, if the policyholder uses the cash value as a tax-free source of retirement income and never pays it back, the borrowed amount plus interest is simply taken from the death benefit. It’s important to read and follow the contract terms carefully to make sure that the policy stays in force whenever the cash value is borrowed.
- Guarantees Provided by Carrier
In addition to being accessible as a source of tax-free income, the cash value in an indexed universal policy also comes with guaranteed principal protection and growth that correlates with a preselected market index. Those guarantees are made by the claims-paying ability of the issuing insurance company, and they can allow you to participate in at least a portion of the market’s upside without subjecting you to its bottomless floor. This can make indexed universal life a helpful tool for those without the stomach or tolerance for market risk. Depending on investment, saving and lifestyle goals, it can also help to diversify a portfolio with a non-correlated asset class that still offers potential market upside.
- Long-Term Care Hybrid Policies
Nearly 70% of today’s 65-year-olds will need some type of long-term care (LTC), and 20% will need it for longer than five years [2]. It’s also important to know that extended stays in long-term care facilities are not covered by Medicare, as they are considered lifestyle expenses as opposed to medical expenses. That means that today’s retirees may want to consider the possibility of needing LTC, as well as a way to cover the potentially exorbitant costs. Modern hybrid policies can give policyholders the option to combine their life coverage with long-term care coverage, eliminating the “use-it-or-lose-it” aspect of long-term care policies of old. If you need the benefit to pay for long-term care, it can be used to pay for those expenses, but if you don’t, it can be converted to a death benefit for your beneficiaries.
What You Should Know Before Purchasing an IUL Policy
As all saving and investing vehicles do, IUL policies have drawbacks that you should be aware of prior to signing on the dotted line. It’s important to recognize that these policies are contracts with an issuing insurance company. As contracts are legally binding agreements that can be complex or skew in the favor of one party, it’s always a good idea to speak with a financial professional who can explain how interest is credited and fees are assessed. Additionally, the fees on IUL policies tend to be higher than those of other types of life insurance, meaning that your cash value and growth can erode if the policy is not properly structured.
It’s also crucial to note that while IULs offer the potential of market upside, the terms of the contract typically guarantee a participation rate at a fraction of the market’s growth, meaning that your cash value may not always grow at the rate of your selected market index. Some may even guarantee growth up to a certain point, called a cap, or they might change the participation rate after a select amount of time contributing to the policy. Again, these are aspects of your policy you should be hyperaware of prior to engaging.
IULs may also come with surrender periods, which are predetermined periods of time that you are not allowed to withdraw funds from the policy. Doing so may force you to incur surrender charges, which can significantly impact the cash value policy in addition to the growth potential. It’s also critical to consider the opportunity cost of a permanent life insurance policy. As mentioned above, IULs can come with capped growth or rates of participation. Investing money directly in the market comes with no ceiling, meaning the potential of your investments can be higher. Granted, market investments also come with no floor, meaning that your investments could plummet and significantly impact your ability to provide for yourself in retirement, but it’s still imperative to weigh your options and speak to your financial professional before making major decisions about your future.
If you’d like to find out if an indexed universal life insurance policy might align with your unique financial circumstances and goals, we can help! Give us a call today to explore your options and build a plan for your future. You can reach United Financial Group LLC in North Manchester, Indiana, at 260-982-1090 or toll-free at 888.342.8918.
Sources:
- https://insurancenewsnet.com/innarticle/indexed-life-sales-up-28-drives-strong-q2-for-life-insurance-wink-says
- https://acl.gov/ltc/basic-needs/how-much-care-will-you-need
This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.
Life Insurance: Several factors will affect the cost and availability of life insurance, including age, health, and the type and amount of insurance purchased. Life insurance policies have expenses, including mortality and other charges. If a policy is surrendered prematurely, the policyholder also may pay surrender charges and have income tax implications. You should consider determining whether you are insurable before implementing a strategy involving life insurance. Any guarantees associated with a policy are dependent on the ability of the issuing insurance company to continue making claim payments.
Indexed universal life insurance policies can offer flexibility and potential for cash value growth, but they come with complexities, costs, and limitations that should be carefully considered. It’s essential to thoroughly research and understand the specific terms and features of any IUL policy before purchasing, and consider consulting with a financial advisor to assess whether it aligns with your financial goals.
