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Indexed universal life insurance (IUL) is a type of permanent coverage. It lasts for your entire life, unlike a term life insurance policy. As long as you keep your premium payments current, your loved ones are guaranteed to receive a cash payout, no matter when you pass away. That’s far and away the number one reason to buy any type of permanent coverage.

But there are other benefits to choosing an IUL policy. Those benefits include:

  • Cash value. All permanent policies include a cash value account. Part of every payment you make gets deposited into this tax-deferred account, which grows over time with interest. Think of this as a type of savings account – the longer you keep your policy, the bigger it grows.
  • Flexibility. You can change your level of coverage, your payment amount, and how often you make that payment. There’s more responsibility for you because you have to be sure you keep your policy funded with at least the minimum payment amount. But if you have seasonal or variable income, that flexibility may be a big benefit. It also gives you a ton of financial flexibility as you juggle other investments and life commitments.
  • Cash value accumulation options. IUL gives you the opportunity to tie your cash value growth to a market index, but you're guaranteed not to lose any money by doing so. You may hear this referred as “upside participation with downside protection.” In a nutshell, you’ll earn higher amounts of interest based on the performance of your chosen index, but you won’t lose anything if it performs poorly.

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The “Index” in Indexed Universal Life Insurance Explained

The cash value portion of your policy is where the action happens. In a typical permanent life insurance policy, like whole life, the cash value grows at a set, small rate of interest set by the insurance company when you buy the policy. IUL is designed to give you the opportunity to earn more interest without risking any loss.

Close up of a person using a tablet to track the performance of a market index to see how their indexed universal life insurance cash value is doing

Here’s how IUL works.

Think of your cash value as a savings account. That account has subaccounts that offer different ways of earning interest. It’s up to you to move money from the main cash value account into subaccounts. One subaccount may offer a low but steady interest rate, making it a safe option. Other subaccounts may offer growth tied to an index, like the S&P 500 or the Dow Jones. If the index you choose makes gains over time, a percentage of that gain is credited to your cash value in that subaccount.

But what happens if your index doesn’t gain? What happens if there’s a big downturn and it loses a percentage of its value?

IUL policies provide either a zero percent or token minimum interest rate (usually less than 2%) credited to your cash value even if the index loses money. You won’t lose anything from your cash value because you’re not actually invested in the index itself. Worst case, your cash value would earn zero interest during that crediting period.

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IUL Words to Know

Life insurance has a vocabulary all its own and IUL is no different. Here are some key terms you should be familiar with as you shop for a policy:

    Woman looking at stock market charts to track her indexed universal life insurance cash value
  • Participation rate. If you have money in a subaccount tied to an index, the percentage of the index’s gain you will get is called the "participation rate." Ideally, you want a participation rate of 100% for the duration of your policy. This means that if the index tied to your subaccount rose 5% during that crediting period, a participation rate of 100% would give you the full 5%. If your participation rate was, say, 80%, you would receive 80% of the index’s 5% gain.
  • Cap. This is the maximum amount of interest that will be credited to your subaccount, regardless of what the index gains. Most caps are between 8% and 12%. For example, if your subaccount is tied to an index that gains 20% during a crediting period but your cap is 12%, you will get 12% credited to your account.
  • Floor. This is the guaranteed minimum interest rate your subaccount will earn. Depending on your insurer and your policy, it might be anything from 0% to 1% or 2%. If your subaccount’s index loses value, your cash value will only be credited with this minimum amount.

When shopping for an IUL policy, you want to pay close attention to the cap rate – that’s the maximum amount you can benefit from great market performance. When you see a sample cap rate, ask yourself: how many years did the index gain more than that percentage rate? If it’s quite often, be aware that you won’t be getting the full benefit of that gain. On the other hand, there’s no risk of losing money since you’re actually invested in the market. It’s a trade-off you need to be aware of. Are you the type who would rather guard against losing or take every chance to win?

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Can I Use My IUL Policy Cash Value?

Yes, you can! And you should – in most cases, your cash value is a “use it or lose it” benefit. It's a great source of supplemental retirement income. Some insurers will let you pass it on to your beneficiary, but not all of them.

You can take tax-free withdrawals up to your policy basis (the total amount of premium you've paid so far). If you need more than what's already in your cash value account, you can take a policy loan. As with any loan, a policy loan comes with a token amount of interest. You can repay the loan if you like, but if you don’t, the insurer will subtract whatever you still owe when you pass away from the death benefit.

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As a financial advisor, I wouldn't recommend borrowing so much that your death benefit decreases, since the goal of the policy is to pass that death benefit to your loved ones if anything happens to you. Overall, cash value is a fantastic way to supplement your retirement, pay off bills, send a child to college, and more.

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Indexed Universal Life Insurance Pros and Cons

Okay, so you know a little more about IUL. But is it right for you? Let’s take a look at the pros and cons.

Pros of an IUL Insurance Policy

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  • Coverage you can’t outlive
  • Tax free death benefit for your beneficiaries
  • Flexibility in payment amount and timing
  • Cash value savings component
  • Ability to earn more cash value when your subaccount indexes do well
  • Zero risk of investment loss
  • Cash value you can access later for retirement funds, healthcare expenses, or anything else you need

Cons of an IUL Insurance Policy

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  • More expensive than term life insurance
  • Cost of coverage increases as you age – less money is deposited into your cash value account
  • Responsibility to make sure your policy is funded
  • Gains from interest crediting are less than gains from regular investments in those same indexes, ETFs, or mutual funds
  • Policy fees, including fees and interest charged for policy loans

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