Securing life insurance benefits for your spouse and other family members in the event of your death is a vital financial step. The life insurance payout can help beneficiaries pay their bills, keep their mortgaged home, and live comfortably.
There are various options for those looking for the right life insurance policy, ranging from inexpensive term life insurance to expensive permanent life insurance policies. Index universal life insurance (IUL) and Whole life insurance are popular options. Individuals considering these options should consider their needs before making a life-long decision.
In this article, we’ll look at the key differences between these policies and offer advice to people trying to choose between them.
Indexed Universal Life Insurance (IUL)
Indexed universal life insurance policies are relatively new portfolios in the insurance industry. As the name implies, their earning potential is linked to an equity index. These policies are generally complex and riskier.
IUL policies allow policyholders to direct all or part of their net premiums to a cash account. This account calculates interest based on the performance of an underlying index, with a minimum return of 0% and a maximum rate of participation or cap imposed on the return.
When you look at how the index exposure is made, things start to get a little less clear. Instead of buying stocks outright, the insurance company usually uses some of the policy premium to buy options contracts. This lets them pass on the upside gains without the downside losses but at the cost of more counterparty risk.
According to a Bishop Company report, most insurance providers offer minimum cap rates ranging from 1% to 4% and participation rates of around 50%. However, some provide non-guaranteed cap rates of about 10% to 14% and more than 100% participation rates in their sales materials.
Even if the underlying index rises by 20%, a policyholder may only see a return of 10% to 13% due to these limits. Using stock options also removes dividends from any index return calculation, which typically account for 2% to 4% of the total market return. Without these returns, policyholders may earn less than the benchmark indices.
• Benefits are guaranteed
- Payment of premiums is flexible
- Chance to earn a higher interest rate
• Opportunity to take out a loan against the policy later in life
• The performance of the stock market determines earnings.
• If the index goes down, returns can be lower, but there are often floors that stop losses from getting worse
• It’s possible that premiums will go up over time
• Making use of complicated derivatives
• Increased costs
• If premium payments fall behind the performance, the death benefit may be reduced or forfeited.
Whole Life Policy
Whole life insurance policies are generally considered the safest bet for those who want to leave a financial legacy for their loved ones. Because of this, it is critical to do extensive research on potential providers to ensure that they are among the very best currently in operation.
• Death benefits are guaranteed.
• Premiums have a fixed rate and do not rise with age
• Loan could be taken against the cash value if needed later in life.
• Interest and cash payments may be exempt from federal income tax.
Making a Choice Between the Whole Life Policy and IUL
The main goal of whole life insurance is to provide life insurance. IUL insurance policies, on the other hand, are more like ways to make money in retirement. The money in these policies grows tax-free and can be used to pay premiums. Furthermore, policyholders can take tax-free distributions from the accrued cash value during retirement to help cover any type of expense â€” useful for those who have already maxed out their Roth IRA and other options. Rather than a guaranteed death benefit, many policies are sold on the idea that they will build up cash value.
It’s crucial to think about how indexed universal life insurers employ derivatives. IUL policies limit the maximum returns in good years and losses in bad years because call options expire worthlessly. If equity indexes have been performing well recently, insurance providers may take advantage of “recency bias” by promoting high returns for IUL policies.
Some IULs also include contractual guarantees known as “riders.” These riders can offer guaranteed benefits similar to those of general account products. Still, people with IUL policies shouldn’t count on high returns from equity indexes to pay for their life insurance over time. When returns are good, it’s easy for policyholders to forget to fund the policy’s cash value, leading to lapses in coverage later. Taking loans from the cash value of an insurance policy and paying interest can also be risky if the interest credited doesn’t cover the cost of the loan.
Unique Features: IUL and Whole Life
Whole life insurance is simple life insurance with a fixed premium. On the other hand, indexed universal life insurance policies are more like retirement income vehicles, with an investment portion that pays an interest rate that matches the growth of an equity index.
How Risky is IUL?
That depends on how you define risk and how much you are willing to take. Those looking for a risk-free policy with no potential for a return on investment should consider whole life insurance. Because IUL policies are riskier, they come with a payoff benefit.
Which is the most secure option?
Those who want to ensure financial security for their loved ones after they pass away should consider purchasing whole life insurance. In addition to providing a death benefit, remember that whole life insurance also has a savings feature where cash value can build up tax-free.
For over 30-years Joe Carreno of The Retirement Advantage has been a Federal Employee Retirement System specialist (FERS) as well as a Florida Retirement System specialist (FRS) independent advocate. An affiliate of PSRE (Public Sector Retirement Educators), a Federal Contractor & Registered Vendor to the Federal Government, also an affiliate of TSP Withdrawal Consultants.
We will help you understand your FERS & FRS Benefits, TSP & Florida D.R.O.P. withdrawal options in detail while recognizing & maximizing all concurrent alternatives available.
Our primary goal is to guide you into retirement with no regrets; safe, predictable, stable, for life. We look forward to visiting with you.
Not affiliated with the U.S. Federal Government, the State of Florida, or any government agency. The firm is not engaged in the practice of law or accounting. Always consult an attorney or tax professional regarding your specific legal or tax situation. Although we make great efforts to ensure the accuracy of the information contained herein we cannot guarantee all information is correct. Any comments regarding guarantees, safe and secure investments & guaranteed income streams or similar refer only to fixed insurance and annuity products. Fixed insurance and annuity product guarantees are subject to the claims‐paying ability of the issuing company. Annuities are long-term products of the insurance industry designed for retirement income. They contain some limitations, including possible withdrawal charges and a market value adjustment that could affect contract values. Annuities are not FDIC insured.