Can You Lose Money in an Indexed Universal Life Policy?

Indexed Universal Life (IUL) insurance policies combine a death benefit with a cash value component that can grow over time. As permanent life insurance, IULs provide financial security to beneficiaries upon the policyholder’s passing. While IULs offer certain protections, their cash value can be reduced, or the policyholder may receive less than initially expected under various circumstances.

How Indexed Universal Life Cash Value Accrues

The cash value in an Indexed Universal Life policy can grow based on a selected stock market index, like the S&P 500, without direct market investment. The insurance company credits interest to the cash value, mirroring a portion of the index’s gains. This mechanism allows for potential growth while protecting against market downturns.

IUL policies feature “caps,” “floors,” and “participation rates.” A “cap” limits the maximum interest rate credited to the cash value, even if the index performs exceptionally well. The “floor” is a guaranteed minimum interest rate, often 0%, protecting the cash value from negative index performance. A “participation rate” determines the percentage of the index’s gain credited to the cash value; for example, an 80% rate on a 10% index gain credits 8% interest. While the 0% floor protects against direct market losses, it does not guarantee positive growth, as ongoing policy charges can still erode the cash value even with zero interest.

Expenses and Their Effect on Cash Value

Indexed Universal Life policies include various charges deducted from the cash value, impacting its growth. The “cost of insurance” (COI) is a primary charge, representing the mortality cost for the death benefit. This charge increases with the policyholder’s age, reflecting rising mortality risk, and can significantly affect the cash value, particularly in later years.

Administrative fees are also deducted, covering policy maintenance costs such as processing paperwork and customer support. These fees typically range from $5 to $15 per month. Additionally, a “premium load” or “expense charge” is often deducted as a percentage of each premium payment before funds are allocated to the cash value. This load can range from 5% to 10% of each payment.

Optional policy riders, providing additional benefits like long-term care coverage or accelerated death benefits, also incur separate charges. Rider costs vary based on the specific benefit and the insured’s characteristics. If credited interest is insufficient to cover these accumulating expenses, the cash value will decline, potentially reducing policy benefits or leading to termination.

Policy Loans, Withdrawals, and Cash Value

Accessing cash value through policy loans or withdrawals can reduce an Indexed Universal Life policy’s overall value and future benefits. When a policy loan is taken, the borrowed amount reduces accessible cash value, and interest is charged on the outstanding balance. Loan interest typically ranges from 6% to 8% and, if unpaid, can compound, further depleting the cash value. If the loan balance, including accrued interest, exceeds the policy’s cash value, the policy could lapse, resulting in lost coverage. While loans are generally tax-free as long as the policy remains in force, they reduce the death benefit payable to beneficiaries if not repaid.

Withdrawals from an IUL policy directly and permanently reduce the cash value. Unlike loans, withdrawals do not need repayment, but they diminish the policy’s future growth potential by reducing the cash value available to earn interest. Withdrawals can also reduce the death benefit. While withdrawals up to the amount of premiums paid are typically tax-free, amounts exceeding premiums paid may be subject to ordinary income tax.

Understanding Policy Lapse and Surrender

An Indexed Universal Life policy can lapse if the cash value becomes insufficient to cover ongoing policy charges. This occurs if premium payments stop, or if credited interest is consistently too low to offset accumulating expenses like the cost of insurance and administrative fees. When a policy lapses, the policyholder loses death benefit protection and any remaining cash value.

Policyholders also face “surrender charges” if they terminate the policy within a certain period, typically the first 10 to 15 years. These fees are levied by the insurance company for early termination, meaning the policyholder might receive significantly less than the accumulated cash value upon surrender. In some cases, surrendering early could result in receiving nothing after these charges. Insufficient funding or poor management can lead to the complete loss of a policy’s benefits and accumulated value.