Is IUL Right For You?
Indexed Universal Life Insurance can grow cash value linked to equity returns, which is a great opportunity but is it right for you? Tax-deferred growth combined with tax-free access to your funds, make IUL policies a desirable option for those seeking death benefit protection and potentially higher returns. However, purchasing an indexed universal life insurance policy is a long-term commitment, as optimal returns may or may not be achieved within a short period of time.
Therefore, it is important to understand whether or not an IUL policy is right for you – and, if so, how your IUL policy should be structured to meet your specific needs. Working with an IUL Expert who is well versed with “indexed universal life insurance pros and cons and can provide you with the details you need for your situation.
Indexed universal life insurance is not a one-size-fits-all solution for all financial needs. But, while it may not be right for everyone, IUL could be a good fit for you if:
- You’re seeking stock market-linked returns without the downside risk.
- You want to lock in your cash value gains.
- You want to ensure that your principal is protected.
- You have maxed out your IRA and/or qualified retirement plan contributions, but you still want to add more funds to a tax-advantaged account.
- You want the opportunity to access your cash value tax-free for supplementing retirement income or other financial needs.
- You want to provide your loved ones with financial protection in case of the unexpected.
When determining whether indexed universal life is right for you, consider some factors before moving forward.
- How much death benefit do you need?
- The policy’s maximum annual increase, or cap, as well as the participation rate.
- The guaranteed minimum interest rate or floor.
- The index (or indexes) that the policy tracks.
- If or how you may want to access the policy’s cash value in the future.
The financial strength and ratings of the insurance company you are considering purchasing the policy through.
Top indexed universal life insurance benefits
Death Benefit
One of the most significant benefits 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 life insurance. Being educated on this need and the benefits can help us understand the importance of life insurance, and in doing so, propel individuals to acquire necessary coverage.
LTC Riders
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 life insurance benefits with additional long-term care coverage.
Revenue Accretion
Having cash on hand during your retirement is an additional and sometimes the most attractive benefit of an IUL. In fact, you might regard this as your most significant motivator in acquiring this type of 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. IUL Policy withdrawals totaling the amount of paid premiums are tax-free. To withdraw from your policy, IULs grant a holder a policy 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.
Gains Locking
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, locking in the past year’s growth and setting a floor for future performance.
IUL Growth and Performance
Typically, insurance providers do not invest your cash values directly 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, unlike stock market investments, you do not receive any dividends from funds held in an IUL. 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 offer 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 to receive 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.
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.
IUL & Taxes
IUL policyholders enjoy tax-deferred growth. Although this is similar to an IRA or 401(k), they differ in several ways. Once you choose 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 withdraw (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 in the form of policy loans. A policyholder can also 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 at any time. Additionally, IULs impose no age restrictions regarding 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 may not have to pay policy loan interest after you begin making withdrawals. Instead, the outstanding and unpaid interest is combined with your total loan balance, which impacts your death benefit.
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 in 2021) would make any Social Security income 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. Creating alternatives for yourself in terms of taking your future retirement income could result in well over $10,000 in annual tax savings.
Disability Rider
Disability insurance riders are available on most life insurance policies. Disability riders ensure the ongoing payment of premiums, keeping your policy active, despite permanent disability. Interestingly, many disability riders pay the amount of the actual premium you made 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
Is IUL The Right Choice For You?
Negative features indexed universal life insurance
Cost of IUL
A negative feature 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, increasing cash values lead to a reduction in the insurance company’s ‘Net Risk.’ In essence, as you grow old, the provider of your insurance focuses on the difference between the death benefit and the cash value. Therefore, the lower net risk is characterized by high-value IUL policies compared to term life or whole life policies that allow for lower costs in the future. Although the simple dollar amounts you may spend for an IUL compared to a Term policy may seem larger today, growth, tax-free loans, and a reduced cost of insurance in the future should sway many savvy investors as they consider whether or not an IUL is right for them.
Limited Earnings
Most insurers limit the amount of gains credited to an IUL policy in any given year in the form of an Index Rate Cap. An index can generate returns above your policy’s cap, but your policy would limit that growth to the policy’s limit. In bull markets, crediting caps will cause the policy to underperform the market, which may disappoint policyholders. However, in negative years, the IUL would essentially remain flat, which for many investors, is a reasonable tradeoff.
Taxation at Death and with Policy Cancelation
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
Insurance and mortality expenses increase as policyholders age. This occurs because your demise is more likely as you become older. Conversely, whole life policies average the total cost over an entire lifetime coupled with fixed premium payments. In the initial stages, IULs are cheaper than whole life policies as a result. However, IULs become progressively more expensive as you age. However, an IUL is designed to minimize a holder’s “net amount of risk “as they age. The effectiveness of your policy and the risks that exist are minimized by ensuring your policy is structured correctly. The simplest way to approach this is to talk with an IUL expert who can help you identify a realistic rate of return and a product that offers the best cost/benefit analysis for your specific circumstances.
Front Loaded Fees And Costs
IUL policies include premium front-loads that affect your policy’s ability to accumulate cash value. “Front loads” typically cover an IUL’s administration expenses such as legal fees, commissions and administrative fees, etc. 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 your health.
Working with a highly-rated expert will allow you to ask questions like;
- Which Front Loads do I need to watch out for?’
- What administrative fees exist, and how does your policy compare to others?
Insurance costs: Both today and in the future
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.
Bottom Line
IUL proponents regard it as the ultimate insurance product. With an IUL, policyholders benefit from death benefit coverage and growth through a fixed contract with no direct investment in the stock markets. Besides that, holders of this policy reap from the boom of the stock markets and have protection against market declines. On the other hand, IUL detractors argue that it is expensive in the long run. Likewise, IULs are perceived as complex financial products that require vigilance from a policyholder or expert advice from a highly-trained expert.
Even so, IUL policies are good investment instruments for the novice,, too, as they have no direct investments to manage. In turn, an IUL’s crediting floor and caps allow the product to achieve growth through a guaranteed product. Ideally, IUL’s are appropriate for those who need insurance, desire higher growth potential compared to fixed products and bonds and have a lower risk tolerance.
There are plenty of proper exits for choosing an IUL. However, you need to proceed with caution and weigh the IUL 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.
Conclusion
In this discussion, we have highlighted why we choose to be proponents of IUL policies. You may still be unsure if an IUL is right for you, but the fact that you are gathering information and learning about how IULs compare to alternative investment and insurance solutions means you are taking the correct initial steps. Talk with an IUL expert and continue exploring the product. We think you’ll find that Indexed Universal Life Insurance is difficult to beat and can be a great addition to most insurance and retirement plans.
