IUL Insurance: What is Index Universal Life Insurance?

Key Takeaway

Indexed universal life insurance (IUL) is a type of permanent life insurance that can offer flexibility to policyholders. Indexed universal life insurance protects your family and also accrues cash value. IUL policies offer  flexibility, the potential to accumulate cash value, and protection for your family with a benefit that is payable upon the death of the insured. But some downsides are potential caps on accumulation and additional costs or fees. It's crucial to keep all these factors in-mind when deciding if an indexed universal life insurance policy is right for you.

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Image of binoculars, compounding interest formula, and slowly increasing bar graph
2/21/2024
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What Does ‘IUL’ Mean?

Indexed universal life insurance (IUL) is a type of permanent life insurance that is often praised for its flexibility for policyholders. An IUL policy can last your entire life while also building cash value. However, these insurance policies can be a little complicated to understand. Indexed universal life policies typically place a portion of the premium payments from the policyholder into an account that has the potential to earn interest that is based, in part, on the performance of a market index - but money isn’t directly invested in the market. Some IUL policies also offer a fixed account option that can earn interest at a set rate.

How Index Universal Policies Work

Indexed universal life insurance policies usually function similarly to fixed universal life insurance policies, with the primary difference being in how they accrue their cash value.  

The cash value in an indexed universal life policy is  tied to a market index, whereas in a typical fixed universal life insurance policy, the cash value may accrue using fixed interest rates that are set by the insurer.  

An IUL policy will usually grow cash value by setting aside a portion of the policyholder’s premium payments and providing the opportunity to earn interest on that amount based in part on the performance of a specified market index. The policyholder’s cash value can grow when the index performance is positive, though it’s important to note that index interest may be subject to limitations such as a cap or participation rate. However, because this type of policy is not an investment, the cash value is not reduced due to negative index performance.  It is important to note that cash value can be reduced due to the policy’s fees and expenses. 

Many IUL policies’ cash values will earn a minimum interest rate no matter how the market performs, but some insurance policies will have an interest rate cap. These interest rates will usually cap between 8% and 12%, but can vary from insurance policy to insurance policy. It is important to note that it is still possible to experience negative performance in these types of policies due to the effects of policy fees and expenses. 

Fixed Universal Life Insurance Versus Indexed Universal Life Insurance

Essentially, IUL is not very different from a fixed universal life insurance policy. Both fixed universal life insurance and IUL policies can offer insurance policyholders a great deal of flexibility. Both have a cash value component and a protection  component, and you may be able to adjust your monthly premiums based on the funds in your cash value However, IUL policies may offer more growth potential than a UL policy.

An Indexed Universal Life Insurance Policy Versus Whole Life Insurance

When searching for permanent life insurance, ‘whole life insurance’ and ‘indexed universal life insurance’ are two terms you’ll commonly see. Both of these insurance policies aim to provide you with lifelong coverage, but the key distinction between the two is how the cash value grows and the cost of coverage. 

In IUL, your cash value is tied (in part) to a market index’s performance. With whole life insurance policies, it’s more straightforward–it’s life insurance where the cash value earns a set interest rate. You pay your insurance premiums, your policy premiums remain at a fixed rate, and your beneficiaries receive a death benefit after your passing. With whole life insurance, the primary focus is permanent coverage with limited potential to grow cash value, so premiums are typically lower than IUL policy premiums. 

Some insurance policyholders may prefer an IUL policy over a whole life insurance policy because IUL policy can offer them increased flexibility with greater potential cash value accumulation. Index UL policies may allow insurance policyholders to adjust their premium rates and/or access their cash value while living. 

Who May Benefit From an Indexed Universal Life Insurance Policy?

Families with dual incomes and individuals with higher net worth who are interested in tax-advantaged savings may find IUL policies appealing, especially if they are seeking flexibility with their life insurance policies.  For these potential buyers, indexed universal life insurance may be a good fit for their objectives. It may be helpful to have strong financial literacy, or to work closely with a professional insurance agent to ensure this type of policy best suits your needs and objectives. It’s important to understand the potential downside of an IUL should the underlying index not perform well.

Advantages of IUL Insurance

Death Benefit

Just like with other permanent life insurance policies, index universal insurance comes with a death benefit. This death benefit is typically not subject to income or estate taxes, and may not be required to undergo the probate process. The death benefit will be paid out to the named beneficiary(ies) upon the passing of the insured person. This death benefit that helps provide for your family after your death is the primary reason people purchase life insurance. 

Flexibility

From flexible insurance premiums to accessing your cash value when you need it, indexed universal insurance can allow you to take the reins when it comes to your policy. Policyholders can increase or lower their insurance premiums (provided their policy values are adequate to sustain the policy) and control the amount they contribute toward their cash value.  

There are insurance policies that can offer a range of optional riders, allowing someone who is shopping for life insurance the ability to find a policy that is best for them and their family. An insurance rider is an addition to an existing insurance policy, which allows you to add features that can help meet your specific needs. It’s always best to speak with a financial professional or licensed insurance agent for education on these policies and how they may be beneficial to you and your family. 

Cash Value

With an indexed universal life insurance policy, the amounts credited to the policy’s cash value can grow tax-deferred. Policyholders may be able to pay their insurance premiums by using their cash value,  allowing them to stop paying premiums, or to pay smaller premium payments. Some policies may offer a rider that will allow the cash value to be added to the death benefit upon the passing of the insured.

Disadvantages of IUL Policies

Limitations on Accumulation

Certain insurance companies will limit the amount of cash value that can be accumulated either through a cap, or other mechanism such as a participation rate. 

Tied to a Stock Market Index

Because the interest earned on the cash value is tied to a market index, this can have both positive and negative effects depending on how that index performs. For example, if the index goes down, the insurance policy may not credit any interest to the cash value. Check that your insurance policy offers a ‘floor’ on losses. A ‘floor’ means there is a minimum interest rate on the indexed account, so in times of negative financial returns, the growth rate credited to the policy will not go below a certain interest rate threshold. While having a floor can help protect against market losses, it is still possible to experience a loss when policy fees and expenses are factored in. Conversely, many IUL policies have a cap – meaning that even if the market performs very well, the cash value you receive may be limited based on your insurance company’s maximum cap.

Additional Costs

Some insurance products may charge additional fees, which can potentially drain your account’s cash value.

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The information above is for educational use only and does not represent insurance, tax or legal advice. It is not a recommendation or solicitation to buy insurance. Please talk to your licensed insurance agent for more information about life insurance and your needs. Please consult with the appropriate professional for tax or legal advice. Guarantees are backed by the claims-paying ability of the issuing insurance company. 

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Article Author: Meredith Bell
Author Bio: Meredith joined Everly in 2022 and has 20+ years of experience in the life insurance industry. She has held various roles in advertising, marketing, communications, sales and distribution support, and product development. Outside of the office, Meredith lives with her daughter Kennedy and their dog Mavis. Meredith enjoys cooking, camping, gardening, hiking, and bourbon (though not always at the same time). She is a live music enthusiast and an avid reader. Her favorite quote is by Thomas Jefferson: "I cannot live without books." Meredith agrees, but would add cheese, movies, and dogs to that list.

Policies are issued by Everly Life Insurance Company (“Everly Life”), Topeka, KS. Everly Life is not licensed in the state of New York and does not solicit or transact business in New York.

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