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What Is Indexed Universal Life Insurance?

Indexed universal life (IUL) insurance is permanent, which means it lasts your entire life and builds cash value. An IUL policy allows for some cash value growth through an equity index account such as the S&P 500 or the Nasdaq Composite, unlike other universal policies that only grow cash value through non-equity earned rates. Like with all universal life policies, once you've built up enough cash value, you can use it to lower or potentially fully pay for your premium without lowering your death benefit.

How Indexed Universal Life Insurance Works

Indexed universal life insurance works similarly to universal life. You pay a premium in exchange for lifelong coverage and can use the cash value account to build an investment. Part of your premium payment goes toward the cost of insurance (covering your death benefit) and other fees, then the rest is added to your cash account.

As with universal life, IUL premiums are adjustable. If you ever decide to skip a premium payment or underpay, that money can be taken directly from the account. You may also be able to adjust the death benefit amount if your needs change. However, you may be asked to complete a medical exam if you apply to increase your coverage.

How IUL Cash Value Accounts Work

The cash value account earns money based on the performance of a selected stock index. A stock index, such as the S&P 500 or Dow Jones Industrial Average, is a way to track a group of stocks. Insurance companies have one or more of these indices you can choose from. The insurer pays interest to policyholders based on the index’s performance — as value goes up, the account earns interest. If the index drops, the account earns less or nothing.

The amount you can earn is subject to “floors” and “caps” to help minimize large swings in interest payments. 

Related: IRS Tax Code 7702 Explained: How It Affects Your Life Insurance

Floors, Caps and Participation Rates

The cash value within an IUL won’t mirror an index’s exact gains and losses:

• Floor: You’ll find there is a floor in place, which is the minimum rate that will be credited to your cash value. Your floor could be 0%, but that will protect you from losses.
• Cap: On the flip side, there is usually a cap, meaning your cash value gains won’t go above a certain percent—even if the index performs above that threshold. For example, if your cap is 10%, and the index goes up 12%, the cash value tied to that index increases by 10%.

Participation Rate: Your cash value gains are also calculated according to the “participation rate,” which is set by the insurance company. This is the portion of the index’s return that is credited to your account. It can often range anywhere from 25% to above 100%. If the IUL has a participation rate of 100%, you will earn all of the interest gained by your investments, up to your cap.

Another example is if the participation rate is 50% and the index gained 10% for the month, you’d actually earn 5% for the period. Though the growth is often tracked monthly, the cash value earnings are usually credited to the account once per year or every five years.

Though the internal policy expenses are deducted monthly, the cash value earnings are only credited to your account at the end of the “segment period” you selected. This could be as long as nine years but is most often once per year and can be as frequently as monthly if you elected dollar cost averaging (DCA).

This means your Annual Policy Statement could show no earnings even in an up market if the end date of the selected segment period is after the date of your Annual Policy Statement. But that doesn’t mean your policy isn’t performing as expected.

While the floor cannot be changed throughout your policy, your insurer will change the cap and/or participation rate in response to changes in market conditions (such as changes in prevailing interest rates, the degree of equity market volatility, and the cost of options in the derivatives market).

Is Indexed Universal Life Right For You?

If you are an investor that leverages Other People Money(OPM) for your investments and need to protect those assets and your family, then an I.U.L. may be for you. As an investor, being able to "become your own bank" through the cash value in your policy becomes game changing when it comes to your investing future. The cost of taking a loan from yourself is typically much lower than traditional forms of funding, which clearly impacts your bottom line.

If you think the stock market will continue going up, and you’re excited about the floors and caps that come with indexed universal life, this may be the right pick.

Indexed universal life is for people who want to get more out of life insurance and see it as an investment.

Also, for consumers who have maxed out their available retirement plans, an IUL could allow them to contribute with fewer age restrictions and potentially grow cash value on a tax-deferred basis.

Click HERE to book your free consultation on setting up your own Indexed Universal Life Insurance policy.