What Is an Indexed Universal Life Policy?
Understand Indexed Universal Life (IUL) policies. Learn how this unique life insurance works, from cash value growth to policy features and illustrations.
Understand Indexed Universal Life (IUL) policies. Learn how this unique life insurance works, from cash value growth to policy features and illustrations.
Indexed Universal Life (IUL) policies represent a type of permanent life insurance designed to offer a death benefit alongside a cash value component. These policies aim to provide lifelong coverage, ensuring financial protection for beneficiaries upon the insured’s passing. A distinguishing characteristic of IUL is the mechanism by which its cash value accumulates, linking potential growth to the performance of a market index. This structure allows for a different approach to cash value accumulation compared to traditional policies.
An Indexed Universal Life policy is a form of permanent life insurance that combines a death benefit with a cash value savings component. The policy remains in force for the insured’s entire life, provided premiums are paid, while also building an accessible cash value. The defining feature of an IUL policy is how its cash value grows. Unlike traditional universal life policies that credit interest at a fixed or declared rate, an IUL links the interest credited to the performance of a chosen market index, such as the S&P 500 or NASDAQ. The policy itself does not directly invest in the stock market or the index. Instead, the index’s performance serves as a benchmark for calculating the interest credited to the policy’s cash value.
The growth of cash value in an Indexed Universal Life policy is determined by a unique “index crediting” method. This means the interest applied to the cash value is tied to the movement of a specific market index. The policy’s funds are not directly invested in the market; instead, the index’s performance calculates the interest rate credited. This system offers the potential for higher returns than fixed-rate policies while providing some protection against market downturns.
Several parameters govern how interest is credited to the cash value:
These rates, including participation rates, cap rates, floor rates, and spreads, are established by the insurance company and can be adjusted over time, impacting future cash value accumulation.
An Indexed Universal Life policy includes several structural elements. Premiums paid by the policyholder cover various costs and contribute to the policy’s cash value. A portion of each premium typically goes towards the cost of insurance, administrative fees, and other charges, with the remainder added to the cash value account.
The death benefit is the sum paid to beneficiaries upon the insured’s passing. Policyholders have options for its structure. Option A, a level death benefit, remains constant. Option B, an increasing death benefit, includes the face amount plus accumulated cash value, leading to a potentially larger payout.
The cash value account serves as a tax-deferred savings component. This fund grows based on the index crediting method, accumulating over the policy’s life. The cash value can be a source of liquidity for the policyholder, separate from the death benefit.
Policy charges are deductions from the cash value or premiums. These typically include the cost of insurance (mortality charges), administrative fees, and premium loads.
Policyholders can access the accumulated cash value within an Indexed Universal Life policy through several methods during their lifetime.
One common approach is taking a policy loan, where the policyholder borrows funds using the cash value as collateral. While interest is charged on the loan, the cash value generally continues to earn interest on its full amount, even the portion collateralizing the loan. If the loan is not repaid, the outstanding balance, including accrued interest, will reduce the death benefit paid to beneficiaries.
Another way to access funds is through withdrawals, which directly reduce the policy’s cash value and, consequently, the death benefit. Withdrawals are generally tax-free up to the amount of premiums paid into the policy, often referred to as the cost basis. Any amount withdrawn exceeding the cost basis may be considered taxable income, representing the earnings on the cash value.
If a policyholder chooses to terminate their policy, they can surrender it. Surrendering an IUL policy means the coverage ends, and the policyholder receives the cash surrender value. This amount is the accumulated cash value minus any outstanding loans and applicable surrender charges. Surrender charges are fees imposed by the insurer, particularly during the early years of the policy, to recoup initial expenses. These charges typically decrease over a specified period, often ranging from 10 to 15 years.
Understanding an Indexed Universal Life policy illustration is important for prospective policyholders. These illustrations are projections based on a set of assumptions, not guarantees, regarding future index performance, interest rates, and policy charges. They provide an estimated view of how the policy might perform over time.
A key aspect is the distinction between “guaranteed” and “non-guaranteed” columns. The guaranteed column presents a worst-case scenario, showing cash value growth based on the minimum floor rate and maximum charges. This provides a conservative benchmark. The non-guaranteed columns project performance based on current or assumed index performance and prevailing policy charges, which are subject to change.
Illustrations detail the specific assumptions used for projections, such as participation rates, cap rates, floor rates, and cost of insurance rates. It is important to understand these assumptions, as they directly influence projected cash value and death benefit growth. Variations in these rates can significantly alter the projected outcomes.
The illustration also provides projections for both cash value and death benefit over time, showing potential growth under stated assumptions. It outlines the projected premium outlay. Given that illustrations are sensitive to changes in assumptions and actual market performance, policyholders should focus on guaranteed values as a baseline and recognize the variability of non-guaranteed projections.