Indexed Universal Life Insurance Policies (IUL)
Indexed Universal Life (IUL) insurance policies are a relatively new ‘hybrid’ product that insurance companies offer, combining the best aspects of the fixed whole life and the variable life insurance.
The main distinguishing feature of this type of life insurance is that it allows you to invest the cash value in index options that follow the movement of an index, such as the Dow Jones Industrial Average and the S&P 500.
Benefits of Indexed Universal Life Insurance
- You can earn a credited interest rate that is higher than traditional cash-value policies, without subjecting yourself to unnecessary risk.
- Just like any permanent life policy, equity indexed universal life insurance provides the cash value element. The difference is that here you have the option to participate indirectly in the upward movement of a stock index without the downside risk associated with the stock market. The interest to the cash values increases with the upward annual movement of a stock index, not including the dividends.
- Indexed universal life offers a number of tax advantages: death proceeds are not subject to tax at death; cash values build up tax-free and there is the possibility of tax-managed earnings for education or retirement.
- With indexed universal life policies, the cash-surrender value can reach an annual growth cap of about 10-14 percent. In years when the equity index is flat, the cash value reaches the floor, which is usually guaranteed to be 0%. Some insurance companies offer a guarantee of a minimum interest rate for a certain period of time.
How an IUL policy works
IUL policies feature a flexible premium and a cash value side fund. When you pay premiums into the policy, the insurance company invests the premiums in the general account of the insurance company. The insurance company, in turn, invests the general account in the general stock market, largely using options. The policy owner receives a guaranteed credit rating, often comparable to a certificate of deposit. If stocks do well, the policy owner also gets credited a portion of stock market returns. If stocks fall, however, the policy owner still gets the minimum credit rating.
Taxation of IUL policies
IUL policies are life insurance policies, which have generally received favorable tax treatment from Congress. There is no tax deduction on premiums paid. But the cash value of the policy grows tax free, and the policy owner can generally access the cash value of the policy tax free at any time, provided the policy remains in force. Since there is no income tax or capital gains tax on the proceeds of withdrawals or loans against in force policies, and since there is no 10 percent penalty on proceeds received prior to age 59-1/2 , IUL policies have become popular savings vehicles for some individuals, especially those who earn too much to qualify for retirement accounts, such as IRAs or 401ks, or who have maximized allowable contributions.
Advantages
Indexed universal life policies have favorable tax treatment, no restrictions on what the cash value can be used for, and provide a tax-free cash death benefit for the policy beneficiary in the event of the death of the insured. Additionally, the cash value in an IUL policy generally receives some creditor protection, depending on the state, and does not count against the family for the purposes of determining need-based financial aid for college. Finally, IUL policies do provide some safety of capital, because the policy owner is guaranteed a minimum crediting rating. However, policy premiums are frequently higher than the guaranteed rate, especially on low-balance cash values.
