Does an IUL Policy Meet Your Needs?
In many ways, Indexed Universal Life Policy is similar to traditional universal life, except IUL uses a different crediting method for determining the accumulation of the cash-value component of the policy.
What makes indexed universal life insurance unique is that the cash value component of the IUL policy can rise based on the performance of an underlying market index, which allows you to get returns that are higher – in some cases, much higher – than those in a traditional universal life policy.
IUL policies will typically also have a guaranteed fixed interest rate, as well as the indexed option. So, most of these policies can ensure that your cash value will not fall below zero – or the minimum “floor” – regardless of what occurs in the market.
When the underlying index performs well in a given year, your cash value will be credited with a high return – usually up to a stated cap rate. If, however, the underlying index has a negative return, your cash value is simply credited with a 0%. So, while you may not have gained during that particular period, you also did not lose.
Depending on the insurance carrier and the policy, there are a number of different market indexes that you can choose from with indexed universal life insurance. These may include the S&P 500, the Nasdaq 100, the Dow Jones Industrial Average, or the Russell 2000. Some IUL policies will allow you to choose from more than just one index.
Indexed Universal Life Crediting Methods
The cash value of an Indexed Universal Life Policy will typically have a guaranteed floor, below which the return will not fall – even if the underlying index performs negatively in a given year.
Whenever the index is above the floor, the cash value account will usually be credited using one of the following methods:
Cap Rate – The cap rate is the maximum crediting rate that is used in the calculation of the index credit. So, if the underlying index returns 8% in a given year, and the cap rate on the IUL policy is 7%, the cash value would be credited with 7%. This rate is typically declared for each index segment in advance of each index period.
Participation Rate – The participation rate is the portion of the index change that is used in the calculation of the index credit. For example, if an IUL policy has a participation rate of 75%, then the cash value will receive 75% of the index movement during the given period. As an example, if the underlying index had a return of 8%, and the policy’s participation rate is 75%, then the cash value would be credited with 6%. (8% x 75% = 6%)
Spread – The indexed return could be determined by subtracting a set percentage from any gain that the underlying index has achieved within a certain period of time. This is known as the spread. For example, if the IUL policy has a spread of 4% and the index increases by 9%, then the cash value would be credited with a 5% return. (9 – 4 = 5)
One of the other key features about indexed universal life insurance is the floor. A floor can help to guard against market-based losses. The floor is the minimum amount of annual interest that the policy will be guaranteed in a given year.
This means that the cash value in the account is guaranteed not to drop below the amount of the floor. In other words, if the floor on the IUL policy is 0%, then the worst that the cash can earn in a given year is 0% – no matter the performance of the underlying index is for that year.
Indexed universal life insurance policies will also have a reset feature. This means that the gain in the cash value component is locked in each policy year – and that amount can never decrease – regardless of what occurs in the underlying index in the future.
Because your cash value is locked in, it can eliminate the need to get back to “even,” and allow gains to continue compounding on top of gains right away. This can cause the performance of an IUL policy’s cash value to look similar to a staircase that is always going up, rather than a chart with numerous up and down market movements.
No Direct Market Participation
With an Indexed Universal Life Policy, the cash value component of the policy can achieve market-like returns, yet without being invested directly in the market itself.