Life insurance is a fairly simple concept: In exchange for paying premiums, your family may receive money upon your death. It’s a way to financially protect your family after you pass, especially if that happens when they still depend on you financially. But there are many varieties of insurance, some of which are considerably more complex. One popular option is indexed universal life (IUL) insurance, which allows the cash value of your policy to grow when certain market indexes are doing well.
What Is Indexed Universal Life (IUL) Insurance?
To understand indexed universal life insurance, it helps to understand the main types of life insurance. Broadly speaking, the two main types are term life insurance and permanent insurance. Within the latter category, permanent insurance, there are many varieties, the most common of which are whole life and universal life. Here’s how they break down:
Term life insurance covers a specific term, ranging from 10 to 30 years. It’s a temporary type of coverage since it covers you for a certain amount of years. If you die within the covered period, your family gets a death benefit, which it can use to cover funeral expenses and replace your lost income. It’s usually less expensive than other insurance options.
Whole life insurance is a permanent policy, which means that there’s no time limit on when your family can receive a benefit. Furthermore, some of the premiums you pay go toward funding a cash value account. Once enough money has gone into that account, it will be used to fund your eventual payout. But you can also use the cash while you’re still alive. You can borrow against it or withdraw from it, much like a retirement account. It has the chance to earn dividends to increase the value of your account. This policy has fixed premiums for the life of the plan.
Universal life insurance is like whole life insurance in that is also a permanent policy, complete with a cash-value account. They’re mainly differentiated by their flexibility, allowing you to adjust your premiums and death benefits. You may also be able to realize higher interest rates on the growth of the cash value, and use that cash value to pay for premiums.
Indexed universal life (IUL) insurance is a type of universal life insurance. Rather than having a fixed interest rate, it’s tied to the performance of a market index, like the S&P 500. Unlike just investing in an index fund, however, you won’t lose money when the market has a down year. This is because your account’s principal is guaranteed, insuring it against market dips. On the other hand, there’s usually a cap on the maximum return you can earn. Many times, you’ll also be able to divide your assets between the fixed and indexed sections of your policy.Pros of IUL Insurance
One of the most attractive features of an IUL is the ability to take advantage of stock market returns without the risk of loss. And it does so while building up a death benefit that will be disbursed to your beneficiaries tax-free.
Other benefits include:
There are many reasons to buy an IUL insurance policy. Like any financial product or policy, though, there are some drawbacks that might hold you back from investing in an IUL. Critics point to high fees associated with permanent life policies, including sales and administrative fees. By contrast, a retirement account, especially one comprised of low-cost ETFs or mutual funds, will lose significantly less to fees.
Someone seeking both life insurance protection and tax-free retirement distributions might be better off getting a term life policy (which tend to be much cheaper) and opening a Roth IRA, rather than trying to combine the benefits into one product.
Other downsides include:
While an IUL policy has some generous upsides, they might not work for everyone.
“If someone has no need for life insurance, then another vehicle may be more appropriate for them,” Abrams says. That might mean just saving in a 401(k) or IRA. Of course, those accounts are subject to contribution limits and don’t offer the same principal guarantees. But less of your investment will be eaten up by fees, and you won’t have a cap on returns when the market has a great year.
Abrams adds, too, that IULs aren’t for short-term investors.
“An IUL is a long term vehicle,” he says. “When saving money in an IUL, you shouldn’t plan on taking any income from [it] for at least 10 years or longer.”
It could be helpful to review your plan with an insurance expert or financial advisor before jumping to get an IUL policy. Your income, long-term financial plans and risk tolerance will determine if getting an IUL is right for you.Saving for Your Retirement
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