What Are the Pros and Cons of Indexed Universal Life Insurance?

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Universal life insurance is a permanent insurance you pay for throughout your life. It offers long-term coverage and can increase in value over time. Indexed universal life insurance falls under the umbrella of universal insurance, but there are some key differences. The primary difference is that stock indexes like the S&P 500 and Nasdaq 100 determine the policy’s cash value. Some insurers also place the cash value in a fixed account unless you instruct otherwise.

The list of indexed universal life insurance pros and cons is extensive. Here’s what to consider. 

What Is Universal Life Insurance?

Indexed universal life insurance is a type of life insurance. Before diving into the pros and cons of indexed universal life insurance, it’s essential to understand the basics of universal life insurance. 

The policies offer coverage until a specific age, usually 95 or 120. The goal is that the policy lasts your entire life. The policies typically provide maximum flexibility since you can adjust the monthly premium and death benefit amount. 

The policies are similar to other types of permanent insurance. You pay the premium throughout your life, and your beneficiaries receive a payment after you die. The policies allow you to build cash value, which you can borrow from as a loan while you’re still alive. 

If you cancel the policy, you can receive the cash value minus the surrender charge. You can also take a loan against the cash value amount and pay it back over time. 

The following features set universal life insurance apart from other types of life insurance.

• Insurance cash value: Universal life insurance policies have a cash value, which you can borrow from while you’re still alive. Most universal life insurance policies have a minimum guaranteed return. Still, it might be lower than the market rate of return.
• Adjustable premiums: You can change your monthly premium amount. You might choose to pay more and add additional funds to the cash value of your policy, or you might need to pay less during some months or years. The policies offer additional flexibility since you can pay using the cash value. 
• Death benefit changes: Most universal life insurance policies also allow you to decrease your death benefit amount, which can be helpful if you have fewer dependents as you age. 

How Is Indexed Universal Life Insurance Different?

Indexed universal life insurance is similar to other types of permanent life insurance. The primary difference is that the performance of a stock index, like the S&P 500 and Nasdaq 100, determines the policy’s cash value.

How Indexed Universal Life Insurance Gains Value

The market index determines your rate of return. When the index gains value, your rate of return increases, and the reverse is also true — when the index loses value, your rate of return decreases. Your policy determines how much cash value you can invest, but it’s usually less than 100%.

Your participation rate determines your earnings. When the index grows, you can earn additional cash value once a year or every five years. 

For example, imagine the index fund grows in value by 5%, and your participation rate is 40%. The current cash value of your policy is $18,000. The policy’s cash value would grow by $360 (0.05 x 0.40 x 18,000 = $360).

If the market index loses value or doesn’t grow, you don’t gain any additional cash value. But you also don’t have any losses. Even though the life insurance company uses the market index to measure growth, the cash value is not in the stock market. Instead, the advisors use the index as a benchmark and add money to the account accordingly. 

Indexed Universal Life Insurance Pros and Cons

The list of index universal life insurance pros and cons is extensive. Here’s what to consider as you decide whether it’s the right product for you. 

Pros

• Earn higher returns: Because indexed universal life insurance tracks stock indexes like the S&P 500 and Nasdaq 100, you can earn higher returns than you would with other types of life insurance policies. Policyholders also have protection from potential losses. 
• Doesn’t impact Social Security: The cash value of your policy — and any loans you borrow against it — doesn’t count toward your income for Social Security. Because of that, it won’t impact how much you get from Social Security during retirement. 
• Tax advantages: The cash value of your indexed life insurance policy can grow tax-free. Plus, your beneficiaries won’t owe any taxes on the money they receive after your death. 

Cons

• Limits on gains: The insurance company can limit the gains you earn. For example, most insurance companies have maximum participation rates that are less than 100%. Because of that, you might be able to earn more money by investing money in the market instead of using an insurance policy. 
• Fees and other costs: Insurers charge fees, and you might also have to pay for other expenses, which can add up quickly. Fees aren’t always straightforward, so it’s essential to ask about them and request a list of fees in writing. 
• Low guarantees: Your life insurance policy might have a minimum guaranteed return, but it’s usually lower than the market rate of return.

How To Decide If Indexed Universal Life Insurance Is the Right Fit

Life insurance is an important part of financial planning, especially when you have dependents or people you support. However, it can be challenging to determine which type of life insurance is the best fit. 

Indexed universal life insurance might be the right option if you’re comfortable with higher monthly premiums, flexible death benefits and tracking an index fund to determine the growth of the cash value. It’s also helpful if you plan to take advantage of some of the tax benefits of the policy, like tax-free growth. 

However, indexed universal life insurance can be expensive since you have to pay fees and you can usually earn higher returns in the stock market. If universal life insurance isn’t the right fit, consider investing in a different type of life insurance, like term life insurance, and tax-advantaged retirement accounts.

Final Take

Indexed universal life insurance is similar to other types of universal life insurance — it provides lifelong coverage and can increase in value over time. Plus, you can take a loan based on the policy’s cash value while you’re still alive. The most significant difference between indexed universal life insurance and other types is what determines the cash value of the policy. Stock indexes like the S&P 500 and Nasdaq 100 determine the cash value. Some policyholders appreciate that the account can benefit from market growth, but others feel the participation rate limits the growth.

Takeaway

Finding and working with a financial advisor is a great idea. A financial advisor will help keep track of your finances and assist you in attaining your financial goals. While finding the right one can be overwhelming, you can decide to work with a financial advisor in your community or a virtual one.Get to know your financial advisor options today for free!

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