Indexed Universal Life Insurance
(And how everything works)
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In recent years, more than 27 million life insurance policies were purchased in the United States, according to the National Association of Insurance Commissioners (NAIC).
A growing number of those financial products (averaging around 20% each year and increasing) are indexed universal life insurance policies.
According to the London International Insurance and Reinsurance Market Association (LIRMA), life insurance ownership in the United States is on the rise, perhaps due to the aging baby boomer generation. Recently, the percentage of those who had a life insurance policy by age group was:
- Younger than 25: 30%
- 25 to 44: 52%
- 45 to 64: 62%
- 65 and older: 69%
No matter what generation you belong to, finding the right life insurance policy can be complex and confusing. Some people like the idea of watching their investment grow and are attracted to permanent life insurance that is tied to the stock market.
However, many people shy away from such policies for fear of losses associated with poorly performing stocks.
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An indexed universal life insurance policy, unlike other permanent life insurance policies, can make your money work for you when the stock market is doing well, but protect your investment when it isn’t.
If you are considering an indexed universal life insurance policy, it’s important to understand all of its moving parts.
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Indexed Universal Life Insurance Made Simple
Indexed universal life insurance is a type of permanent life insurance with a subaccount that can accrue cash value; the earnings rate is attached to a financial index such as a stock index. A stock index is a way to track the performance of the stock market by computing the prices of selected stocks.
It also allows investors and financial professionals to compare the value of specific investments. The Standard and Poor’s 500 is a commonly used stock index; it is the value of 500 stocks that is tracked every day on the financial markets.
This type of policy offers the advantages of earning interest on your investment without the drawbacks of losses tied to the whims of the stock market.
These policies are designed to offer more stability, so the premiums aren’t directly invested in the stock market like variable universal life insurance premiums. Instead, the financial value of the index is used to calculate how much interest is credited to your indexed universal life insurance policy’s cash account.
The insurance company will cap or limit the maximum amount that can be credited to your account and also buffer your downside with a guaranteed interest rate if the stocks decline in value. The insurance company’s ability to credit your account depends on how well the carrier’s investment portfolio (commonly bonds) performs.
In other words, when the stock market does well, your investment in the policy grows accordingly up to the cap. You may choose a guaranteed interest rate in the event the company’s portfolio does poorly, or accept a zero percent growth in your cash account during that time.
With an indexed universal life insurance policy, the crediting rate for your cash value is determined by a formula, instead of being at the insurance company’s discretion.
The specific formula is outlined in the policy documents, but is usually related to the performance of the stock market. You should always examine this formula carefully to understand your projected rate of return.
Who Should Purchase Indexed Universal Life Insurance?
This type of insurance is appropriate for people who have a need for permanent life insurance protection, like leaving money to their children or grandchildren, supplementing their retirement income, or maintaining a spouse’s lifestyle at their death.
The top reasons any type of life insurance was bought in the United States in 2011, according to LIRMA, included:
- Income replacement: 54%
- Cover burial and other final expenses: 49%
- Guarantee payment of a mortgage: 23%
- Transfer wealth to family: 19%
- Replace another policy: 13%
- Pay for college education: 12%
An indexed universal life insurance policy can accomplish any of these goals. You may already have a traditional term life insurance policy and be looking for a way to diversify your retirement portfolio, or you may want to take advantage of the tax savings permanent life insurance policies can offer.
Like many, you may be on the fence as to whether you should purchase additional coverage. You understandably want to be comfortable with and knowledgeable about any type of insurance investment.
It is critical to work with an experienced insurance agent who can help you navigate your options and thoroughly explain any indexed universal life insurance product.
Why Choose Indexed Universal Coverage over Other Life Insurance Policies?
Advantages of an indexed universal life insurance policy may include above-average returns when the stock market does well, but protection when it doesn’t – a feature many variable life insurance policies do not offer.
Additionally, policy loans are allowed and are tax-free, and the loan does not have to be repaid. However, if a policy is surrendered, any outstanding loan is subject to income tax in the year that the policy lapsed.
The death benefits of an indexed universal life insurance policy are also tax-free. And income tax will be deferred for growth in the cash value account, like an IRA. There are no limits on the amount of money that you can contribute each year.
The death benefits are not subject to a lengthy probate process like some wills, and the face amount is paid directly to the policy beneficiary. You can access money in the policy without an IRS penalty, regardless of your age.
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Where Can I Learn More about Indexed Universal Life Insurance?
Life insurance companies spent more than $27 million on advertising in 2013, according to Schonfeld & Associates. The money was not spent idly. Insurance companies are very aware that many potential customers may not fully understand the financial products they are selling.
If you contact a broker from one of the major insurance providers about indexed universal life insurance, you may be shown an example with a crediting rate of, say, 10% or 12% based on using the stock index.
However, in 2014, the net rate of return on life insurers’ invested assets was an average of 4.61%, according to the NAIC. Be wary of insurance companies that promise unrealistic returns.
You want to work with an agent who is not subject to an insurance company’s bottom line. Knowledgeable, experienced and independent agents are always available to answer any questions you may have and assist you in determining your life insurance needs.
These agents work for you, not the insurance company, enabling them to be upfront about your policy’s likely returns and projected performance. Contact an agent to find out how an indexed universal life insurance policy can help you accomplish your financial goals.