Advantages and Disadvantages of Universal Index Life Insurance
By | John Preston
Indexed Universal Life (IUL) insurance has attracted a lot of interest among those looking for a small investment with their life insurance protection these days. IUL, also known as stock-indexed universal life insurance, is similar to a hybrid vehicle.
Like any life insurance product, it guarantees a death benefit. And, like other types of universal life insurance, IUL has a cash value that increases over time as premiums are paid.
Why choose Indexed Universal Life (IUL)?
The difference with IUL is that the insured can link up to 100% of the policy’s cash value to a stock index, such as the S&P 500 or Nasdaq 100. The remainder, if any, goes into a fixed account. If the indexed account shows gains (usually calculated over a month), a percentage of the interest income, called the “participation rate,” is added to the policy’s cash value. If the index decreases in value or remains constant, the insured’s account contributes little or nothing.
Although they function similarly to a security, IULs are not considered investment securities. “It just came to our attention then [actually] invested in the market or an index. The index is just a measuring device to determine the interest rate in the cash value account,” explains Jordan Niefeld, CPA, CFP, Raymond James & Associates of Adventure, Fla.
As with any type of universal life insurance, it is essential that you carefully research each company being considered to see if it is one of the best universal life insurance companies currently in operation.
The other way around
The most significant benefit of UI insurance is the potential for cash earnings, earnings that can be significantly higher than possible for many other types of financial products, including traditional universal life policies or whole life insurance policies.
Policyholders also benefit from a credit level, typically 0% or 1%, so existing cash value is protected from loss in a poorly performing market. “If the index generates a negative return, the client does not participate in a negative credit rate,” Niefeld says. In other words, the account will not lose its original cash value.
The cash value accumulates tax-deferred, and the death benefit is tax-free for beneficiaries. Loans against the policy are also tax-exempt in many cases. Premiums are paid in after-tax dollars, so partial and full withdrawals (up to the amount of premiums paid) are also tax-free.
Niefeld lists a variety of adults that are available to make the policy more attractive (and more valuable), including guaranteed premiums, guaranteed death benefits, and critical illness and long-term care provisions.
Cash increases are limited by the insurer. The insurer makes money by keeping part of the profits, including anything over the maximum limit. “The interest rate cap is 10-12%, depending on the product,” Niefeld explains. “If the index generates a return above the ceiling, the maximum credit rate is based on the ceiling.”
The loan ceiling could prove disappointing in a runaway bubble market, Niefeld warns. In this case, the investor’s money is blocked in an account that may malfunction for other investments. Likewise, the insured will not be able to obtain any benefit. “A series of negative index returns can generate an interest rate of 0%,” he warns.
The companies that sell the policies inevitably present the potential rate of return in its most favorable light. Of course, high returns are not guaranteed by any sales representative who wants to keep their license to sell, but many of the consultants who steer clear of IUL products pragmatically point out that the returns may be much lower than they are told. encouraged to anticipate Lack of understanding of complex calculations can also contribute to unrealistic expectations: Policyholders may not fully understand the costs that inevitably lead to profit
As with any stock related product, IUL is not 100% secure. IUL insurance carries a higher risk than standard universal life insurance, but less than variable life insurance policies (which actually invest in stocks and bonds). “Additional risk for the customer is due to fluctuations in the interest rate of the credit,” says Niefeld.
Premiums could also increase. Although it is designed to remain stable, “if the measurement index consistently performs below the anticipated rate, premiums may increase in future years.”
In the event of death with outstanding loans against the policy, the outstanding loan proceeds may be subject to regular income tax. If the policy is canceled, the earnings become taxable as income. Losses are not deductible.
Taxes and costs
Fees are typically collected upfront and incorporated into complex loan rate calculations, which can be confusing to some investors. The fees can be very high. The costs vary from one insurer to another and also depend on the age and health of the insured.
Some rates to watch include:
- premium expense – usually deducted from the premium before it is applied to the cash value
- Administrative costs – Usually deducted monthly from the cash value of the policy
- Insurance costs – additional policy deductions to cover death benefit, fringe benefits and adults
- Fees and commissions – some policies charge annual or up-front fees to create or manage the account
- Shipping costs – the amount lost if the policy is canceled or if loans or withdrawals are made. In some cases, a partial withdrawal will also permanently reduce the death benefit.
Canceling or giving up a policy may result in higher costs. In this case, “the refund amount may be less than the accrued premiums paid,” Niefeld says.
For followers, an IUL policy is the best of both worlds. Along with a death benefit, policyholders receive a fixed contract with no direct investment in the market. They reap all (or many) of the benefits of stock market booms and are shielded from the pain of explosions.
Detractors warn that IULs can be expensive, with a multitude of hidden fees and costs. In addition, they are complex and advanced financial products that require in-depth knowledge on the part of the insured.
However, an IUL policy could be a good investment option for the inexperienced, as there are no real investment options to make. Due to its shortcomings and limitations, the IUL “is much closer to a fixed income product than it is to an equity product,” Niefeld says. The ideal client is “a person who wants/needs life insurance, has no risk tolerance for a variable product, [but] he would risk [in order] to receive a higher credit rate than a fixed rate of return.” .