What is an Indexed Universal Life Insurance Policy?

If you’ve been reading our posts, you, hopefully, understand the difference between term and permanent life insurance. Each has their own pros and cons that should be considered when deciding how to spend your hard-earned dollars. If you think permanent insurance is the route your family should take, there are quite a few options you should consider.

For many, understanding life insurance is confusing. The language is complicated and the various options make it that much more daunting. Once you understand the concepts behind it though, it’s fairly easy to understand. Today, we wanted to delve a little deeper into our favorite Universal Life policy – the Indexed UL, along with its pros and cons.

Let’s start with a brief definition of Universal Life.

What is Universal Life Insurance?

Universal life insurance gained traction in the late 70s and early 80s. Consumers were frustrated with the small returns on their Whole Life policies and began removing their cash value to explore other investment options. Rather than restructuring how they paid dividends, many insurance companies decided to create a new product. And the Universal Life Insurance (UL) was born.

While the UL is a permanent policy, it has often been described as having a term framework. Essentially, it is a savings account attached to a term policy. A term policy remains active, as long as the premiums are paid, until the agreed upon term length is over (120 years is standard). Unlike term, the UL doesn’t have a set length of time. It remains in place as long as the savings account maintains cash value and the policy’s expenses are paid. The policy starts out very cheap and increases incrementally as you age. For those who consistently maintain cash value in their account, the interest earned is generally high enough to cover the premium charges due upon each renewal.

Earned interest rates are set by the issuing insurance company. They are typically competitive with market interest rates and many companies offer an interest increase once the policy has reached ten years. Interest is credited to the cash portion of the account; dividends are not offered on a UL. If performance or mortality experience is higher than expected, many insurance carriers will pass this on to their policyholders in one of two ways: a reduction in term costs or as an increase in interest credited.

What is an Indexed Universal Life Policy?

Indexed Universal Life insurance is a UL policy that offers it’s policyholders two options – an earned fixed interest rate paid on cash values or a rate that fluctuates based off the movement of the index the client has chosen. While the S&P 500 is the most popular option, the followed index varies from company to company.

Due to the indexing feature, many consumers are led to believe they are exposing themselves to the risks of the stock market. This is untrue and should not be presented as such.

The index is simply the insurance company’s method of determining the interest rate the Indexed UL policy will earn. The indexing feature has a “participation rate” that defines how much of the index’s rise will go towards the policy’s interest rate. This varies from product to product, but many have a 100% participation rate, meaning whatever movement the index makes, the policy will as well (up to the cap).

As mentioned, the indexing feature will generally have a cap on it. Let’s say, for example, if the cap is set for the 13% in the S&P 500. If the S&P rises above 13%, the maximum the Indexed UL will earn is 13%.

The Pros and Cons of an Indexed Universal Life Policy

One of the biggest advantages of an Indexed UL is flexibility. The policyholder has complete flexibility and control regarding their premium amount and timing. If one falls on hard times, the planned premiums can be reduced down to zero, with these reductions made in the coming years.

For those looking for positive growth, without exposing themselves to the volatility of the stock market, an Indexed UL is a great choice. Additionally, you have the option of withdrawing cash from your policy at any time, without facing the stiff penalties and restrictions that come with early withdrawal from your retirement account.

As with anything, however, the UL does have a few cons that should be considered. Many of these policies are loaded with set-up fees that can take several years to pay off. If you’re hoping for positive growth in your cash fund right away, be sure to discuss your goals with your insurance agent, as this might not be the policy for you.

Some consumers are looking for a product that offers strong positive growth. The insurance company has their own process to determine how much cash you’ll gain from the S&P increase. They also impose an earnings cap. Make sure you understand all of the policy’s restrictions before making your final decision.

Due to its flexibility and cash value growth, the Indexed Universal Life product is one of the fastest growing life insurance products on the market. As we’ve mentioned in the past, however, there is no one-size-fits-all policy for consumers. If you’re ready to learn which policies fit your family’s needs and would like to learn more about this product, don’t hesitate to contact us. And stay tuned in the coming weeks, as we further explore the intricacies of Universal Life policies.