Indexed life assurance is a product that confers cash value growth and protection benefits upon an individual’s demise. With this product, accumulated interests are paid to a policy at a predetermined rate based on a formula that monitors specific stock indexes over time, commonly known as a segment.
Many disparaging articles are in circulation regarding what is IUL. Often, individuals and companies that dislike alternative investment instruments publish these articles (for instance mutual funds). Given that, this article will show you, the reader, a comprehensive snapshot of the advantages and disadvantages of Indexed Universal Life.
What are IUL Insurance Riders?
With a host of IUL riders present in the market, here is a list of the best:
Accelerated Benefit Rider – a portion of benefits paid to cater for healthcare
Adjustable Term Insurance Rider – increases a lump sum by integrating a term life policy
Additional Insured Rider – extends coverage to spouse or children
Chronic Illness Rider – portion of benefits paid to offset costs of chronic illness
Long-Term Care Rider – provides income to cater for long-term care expenses of a policyholder in a nursing home, home care or assisted living facilities
The IUL & Its Pros and Cons
Knowing the pros and cons of IUL can contribute to increased peace of mind and quieter nights for IUL policyholders. No matter what you opt for, permanent life insurance or term life policy, it is essential to comprehend that a policy’s initial cost is a major differentiating factor. Typically, price is a major disadvantage of indexed universal life in comparison to term life insurance. For instance, if you have a disposable income of less than $50 after catering for necessities and you need coverage, we recommend that you go for level term life insurance. If you are looking for growth, stability, tax breaks, and protection during retirement, keep reading. Getting an indexed universal life policy can financially secure your future. Although you might think that you are ineligible, you are better off with a good grasp of the basics.
Top Indexed Universal Life Pros
In this section, we discuss the top advantages of an IUL policy.
One of the most significant pros of an IUL policy is the Death Benefit. An IUL is an insurance product that lets holders insure the ultimate asset: your life. Most of us can agree on the importance of doing so. Losing a loved one leaves a void that money can never fill, but dealing with the death of a loved one with the addition of financial hardship can significantly affect your family’s mental health and well-being. A majority of us fail to appreciate the significance of a life insurance policy, and only by being educated on this need can we recognize the importance of life insurance. Doing so will propel individuals to acquire necessary coverage.
Nowadays, insurance policies that combine long-term care are becoming increasingly popular. Alternatively known as hybrid life and long-term care, LTC Riders provide all of life insurance’s benefits with additional long-term care coverage.
Having cash on hand during your retirement is the second upside of an IUL. If you get to live long enough, you might regard this as your most significant motivator in the acquisition of an insurance policy. You can accrue cash value using either a Fixed Value Account or an Index Participation Rate Account. IULs are permanent life insurance policies that have a cash value (CV) accumulation clause. As you remit policy premiums, its cash value accumulates. Besides that, you can access and spend this cash value as per your needs. Policy withdrawals totaling the amount of paid premiums are tax-free. To withdraw from your policy, IULs grant a holder a policy/swap loan against your account’s cash value. Also, IULs limit the amount of premium affluent individuals can remit into a policy; usually it is a percentage of its total cost. Providers do so to avoid the IRS taxing a policy as a modified endowment contract (MEC). Because of this fact, an IUL cannot serve as a complete tax shelter for any disposable income you have.
Each year, IULs lock in any accumulated gains, insurers lump accrued income together with any cash value held in your account, and all credited interest is added to an account on the Index Crediting Date. In essence, this is analogous to the reset button. However, you cannot access any locked in interest as it will cause adverse index performance. To illustrate, let us analyze what happens to invested funds. Investing in the markets has similar pros and cons to indexed universal life products. An advantage of financial markets is that investors get to reap rewards during a market’s upward trend. Also, investors can earn from corporate dividends. Conversely, stockholders can reap negative returns during a market’s downward spiral possibly wiping out any consolidated gains. Though this is unlikely, it potentially can happen. However, you may interject:
“What about IUL policies?”
Typically, insurance providers do not invest held cash values in the stock markets. Instead, policyholders receive returns pegged on the performance of a specific market index, known as the Index Participation Rate. Often, these gains are capped.
Insurance policies typically define limits, with most providers capping maximums in the low 10s with minimums of 1%. For instance, it is impossible to earn returns above the Index Cap Rate max of 13% even though the index the policy is attached to exceeds projected values. In the case that an index performs negatively or has a zero year, insurers pay no returns. Similarly, you do not receive any dividends from funds held in an IUL, in contrast to stock market investments. Even so, with IULs you have the confidence that any annual gains are safely tucked away and won’t disappear.
Protection Against Market Loss
An impressive aspect of indexed universal life is the ability to protect a policyholder against market losses. Typically, insurers pay you a 1% annual guarantee on any of your accumulated cash values. For instance, if the market index performs poorly in any year, you are guaranteed of receiving a discount on your cash value known as the Index Floor Rate. The Index Floor Rate helps protect your cash in a bearish market, facilitating your financial goal. In some cases, insurers have gone under failing to pay the Index Floor Rate, but often these are the exception rather than the rule. Where this happens, governments are quick to step in and remedy the situation. Also, other insurance providers have convenient products that can help keep you achieve your financial goal.
IULs Impose No Mandatory Distribution Requirements
IULs do not require mandatory distribution when preparing for your retirement. Having an IRA or 401(k) allows you to make withdrawals only after you turn 70. Why is this so? Mandatory withdrawals make your funds available for taxation. Note that IULs defer your taxes, but they do not make you exempt from taxation. As IULs have no compulsory withdrawal requirements, your path to financial security is much easier and safer. Also, you have the option of restricting distributions if you happen to be working at the age of 70. However, once you stop working, it is mandatory that you make a withdrawal.
Upward Growth Potential
An IUL policy poses challenges, especially if you need to fund an irrevocable life insurance trust such as estate planning. Accordingly, this implies that holders avoid the risks inherent in the stock markets to leverage the probability of a bull market. A gain of 10% in value of a policy is tracking index results in 10% cash value attribution. For index increase 0f 20%, Index Cap Rate is credited to your account. During the ‘90s, when market volatility and unpredictability was high, providers desired products that would guarantee upward gains in the event of 10%, 20%, or higher index performance. Moreover, IULs was born with its associated cap rate. Furthermore, indexes returned above the cap offset losses incurred in years of negative or zero performance. For those looking to build their finances gradually, this approach is convenient and appealing. Despite the availability of alternatives, for example, a dividend-paying whole life policy, an IUL lets you embrace infinite banking as driving force for your financial upward mobility. Given that, it is important that you educate yourself regarding this concept, as its proper application is a massively positive transformation in your life.
IUL policyholders enjoy tax-deferred cash flow. Although this is similar to an IRA or 401(k), they differ in several ways. Once you chose an IUL to accumulate cash value with protection while working, any policy you hold is treated as a tax-deferred instrument. Its cash value increases without a requirement to pay tax on this growth. However, you must pay taxes on growth if you decide to close or withdrawal (exempt policy loans) from an account. In contrast to IRA or 401(k) accounts, IULs have a mechanism for accessing funds tax-free with no penalties. A policyholder can withdraw cash equal to paid premiums tax-free as you use after-tax dollars to remit premiums.
Accessible Cash Value
IULs let you access your cash deposits any time during regular business hours. Besides, IULs impose no age restrictions regarding any held cash value withdrawals. That is another advantage, as majorities of tax-deferring instruments restrict withdrawals based on your age. Typically, you must be 59.5 years old to initiate a withdrawal. Withdrawals made before time lead to penalties or further limitations.
Although IRAs have different requirements for age distributions or emergencies, they are more restrictive than IULs. Moreover, another plus for IULs is that you do not have to pay a policy loan interest. Instead, any outstanding arrears plus unpaid interest is combined with your total loan balance.
Social Security Taxes
IULs do not affect the amount of your Social Security taxes. Any income you make from Social Security during your retirement is taxable. IRA income above the limit ($25k individual or $32k joint) necessarily makes your Social Security taxable. For example, a salary of $24,000 from Social Security and $40,000 from IRA with no write-offs or a mortgage places one in a higher wage bracket. As a result, this means any benefits you have are taxable. Conversely, an IUL policy loan of $40,000 does not comprise income; therefore, it is exempt from taxation. Individuals or families with an annual salary of $80,000 make tax savings of $10,000, a significant amount in these days.
The last pro of an IUL is the disability rider available on most life insurance policies. Disability riders ensure continuous premiums remittance of keeping your policy active despite permanent disability. However, a disability rider remits the actual premiums amount you used to make before disability even if you were overpaying. A disability rider is affordable and offers tremendous benefits as it can pay your insurance premiums in case of disability. Also, this rider is suitable if you need to set up a succession plan: either buy-sell agreement funded life insurance or key main life insurance.
Top Cons of Indexed Universal Life
A major con of indexed universal life is the price. There is no way out, initially indexed universal life policies cost more than term life policies. Nonetheless, the amount of accumulated cash value will make the policy benefits in the future.
However, what does that entail?
Increasing cash values lead to a reduction in your net risk. In essence, as you grow old, your insurer focuses on the clauses of an IUL that represent a threat to him. Therefore, lower net risk characterized high-value IUL policies in comparison to term life or whole life policies. Besides, a low level of risks helps in managing your premiums.
Another IUL con is that it is sensitive and requires advanced competence and management skills than other policy types. A level-term life policy is the easiest to manage as premiums are set at a fixed rate. However, this policy expires once an initial term is over. Nonetheless, its use of fixed premiums simplifies its operation. Though similar to level term life, whole life term insurance is easy to run due to fixed guarantees on premiums. In short, holders know what they must pay reducing the administration processes. On the other hand, an IULs value rises or falls depending on its terms and index performance. In some cases, you may not make any remittances at all whereas you may need to make hefty payments just to keep a policy active. So there you have it! However, there is a caveat- keep in mind that with an IUL policy, you need lots of diligence or you risk losing your investments.
Most insurers limit the number of gains accrued by an IUL account. Your provider reserves a portion of your gains as well as any income above the Index Rate Cap. Depending on the term of an IUL policy, the maximum crediting rate is capped at between 10% to 13%. Though an index can generate returns above the cap, an IUL’s crediting rate is based on the cap. Given a bull market, crediting caps are bound to disappoint policyholders. In this case, your investment is tied in an account that underperforms relative to other investments. Besides, any progressive negative index performance results in a 0% crediting rate.
Problems with the Hook
Often insurers may exaggerate an IUL’s potential rates of return to get you hooked. Beware of this technique, as sales reps are more concerned with retaining licensing cannot guarantee claimed impressive returns. Opinions from industry experts indicate that IUL returns may be lower than you expect. Besides, a failure to understand how returns are calculated may cause unrealistic expectations. For instance, costs and deductions involved in an IUL may eat significant portions of your profits.
Just as any instrument pegged to equities, an IUL’s safety is not guaranteed a 100%. IUL policies are riskier than standard universal life policies though it is lower than for variable life insurance (stock and bond investments). Note that fluctuation in interest crediting rates increase an IUL’s risks. A further shortcoming of IUL’s is the possibility of a hike in the premiums you pay. Although IUL’s offer maximum investment stability, an index’s consistent negative or poor performance may hike your premium remittances.
With IUL, any outstanding policy loans, funds become taxable in case of death. To add to that, any accrued gains are subject to taxation if a policy is canceled. Any losses against the policy are nondeductible as well.
Increasing Mortality Charges
A host of insurance and mortality expenses accompanies indexed universal life policies as you age. Death benefits terms determine the amount of these costs. Given that, it is imperative IULs are set up correctly to minimize these charges later on in life. For instance, for every $1,000 there is an annual increase in cost, as you grow older. This occurs because your demise is more likely with increasing age. Conversely, whole life policies average the total cost over an entire lifetime coupled with fixed premium remittances. In the initial stages, IULs are cheaper becoming progressively expensive down the road. As a result, if you are not adequately prepared, your insurance cost can skyrocket detrimentally. Keep it in mind that aggressive sales reps do not sell you a product that can lapse during your retirement or old age. However, this can potentially happen. However, it is not the intention of a sales rep. On the contrary, an IUL is designed to minimize a holder’s “net amount of risk “as they age.
Front Loaded Fees and Costs
IUL policies include premium front loads that affect your policy’s ability to accumulate cash value. Fronts loads typically cover an IUL’s administration expenses such as the agent commissions, salaries, postage, legal fees, and rent. Even so, these changes are temporary and are distributed over a period to cushion you against their impact. Nonetheless, how these fees and front loads are determined is often confusing to the average policyholder. Besides, these costs vary significantly between policy providers, your age, and health.
You might be asking, ‘Which frontloads do I need to watch out for?’
Premium expense fees: typically deducted from a premium before it is credited to your cash value
Administrative fees: monthly deductions from your policy’s cash value
Insurance costs: extra deduction obtained from a policy to cater for death benefits
Commission fees: upfront or annual charges for managing an IUL account
Surrender charges: percentage of funds forfeited if a policy is canceled, or when loans and withdrawals are granted. Caveat! In some instances, partial removal can result in a reduction of the death benefit.
IUL proponents regard it as the ultimate insurance product. With an IUL, policyholders get access to death benefits and a fixed contract that has no direct investment in the stock markets. Besides that, holders of this policy get to reap from the boom of the stock markets and have protection against its busts. On the other hand, IUL detractors argue that is expensive in the long-term due to its hidden costs and fees. Likewise, IULs are complex financial products that require vigilance from a policyholder.
Even so, IUL policies are good investment instruments for the novice, as they have no investment options on which to deliberate. In turn, due to an IUL’s crediting floor and caps, it is analogous to fixed income products than equity instruments. Ideally, IUL’s are appropriate to those who need insurance and have a low level of risk tolerance for variable products but desire higher crediting rates in contrast to fixed rates of return.
There are plenty of proper exits for choosing an IUL. However, you need to proceed with caution, and weigh its pros and cons against your unique needs. Although it is a complex product, educating yourself and annually consulting your agent can help you navigate any challenges.
In this discussion, we have highlighted what is IUL and the benefits conferred by an IUL policy. You might lack the prerequisite for this product, but in case you do, contact us for a demonstration of all our available products. An IUL policy is a concrete and dependable insurance product with a host of benefits to its holder. If you relish the taste of bull markets and detest the bite of the bears, it is the ideal product for you.
We are an objective agency that represents a diverse coterie of insurance companies. We advise consumers about insurance products that suit their distinctive needs. As an agency, we are impartial, and we do not compel consumers to sign up for products that cannot meet their needs. Our clientele base comprises our primary reason for existence.
At Indexeduniversal.life, you can access free insurance consultations. Plus, our team is empathetic and can assist you in your quest for the best possible policy. The question is: What are you going to do? You need to do educate yourself to stay in the loop. If you need additional assistance or have issues, do not drag your feet! Reach out to us! We would love to help you! Doing so will help you make an educated decision.