Indexed universal life, explained

Indexed universal life, usually shortened to IUL, is one of the most discussed and most misunderstood forms of life insurance.  It is described by some as an investment and by others as an expensive gimmick.  It is neither.  It is a permanent life insurance policy with a flexible premium and a cash value that earns interest linked to the performance of a market index.

This article explains each moving part in plain English, so you can judge whether an IUL fits a specific goal, and so you can read an illustration with confidence if one is ever put in front of you.

The policy in four ideas

Every IUL combines a death benefit, a cash value account, flexible premiums, and index-linked crediting.  Each one has strengths, and each one carries rules worth understanding before you buy.

What an IUL is not

• It is not a stock market investment.  You do not own the index, and the policy holds no shares.
• It is not a guaranteed-return product.  Credits depend on the index and on the carrier’s formula, and can be zero in a given period.
• It is not a substitute for term insurance.  For temporary needs, term may cost far less.  That comparison is in how term life insurance works.

An IUL is life insurance first.  The cash value is a feature of the policy, not a substitute for an investment account.

Where each premium dollar goes

An IUL is built from a handful of components.  Understanding the order in which money moves through the policy explains most of the questions people have.

• Premium is paid.  You pay a premium, within limits set by the contract and tax law.
• Charges are deducted.  Monthly charges for the cost of insurance, administration, and any riders come out first.
• The rest builds cash value.  What remains is credited to the policy’s cash value account.
• Index credits are applied.  The cash value earns interest linked to an index, subject to the policy’s rules.

How interest is credited

The policy does not own the index or any stocks.  Instead, the carrier credits interest to your cash value based on how a chosen index performs over a set period, often a year.  If the index rises, credits are applied according to the contract’s formula.  If the index falls, the credit for that period is zero, and not a loss.

Carriers use different formulas to turn index performance into a credit.  Some cap the credit at a maximum, some apply a participation rate that credits only a share of the index gain, and some deduct a spread.  The formula, and whether it can change over time, has a large effect on results, so review it closely before you decide.

Here is one hypothetical year, not a rate anyone will receive.  If the index is up 10% and the cap is 9%, the credit is 9%.  If the index is down, the credit for that period is zero, not a loss of cash value.  The index credit also does not include dividends the stocks in the index would have paid.  You do not own those stocks.

What the floor does

• A down index year does not reduce your cash value because of market performance.
• Credits reset each period, so a gain in one year is not given back in the next.
• The floor applies to index credits, not to every other charge in the policy.
• Over time, steady credits can help offset the cost of insurance.

What the floor does not do

• It does not stop monthly policy charges from being deducted.
• It does not make a policy stay in force if it is underfunded.
• It does not guarantee any particular rate of return.
• Policy loans, withdrawals, and surrender charges can still reduce what you receive.

What it costs, how you use it, and how it is taxed

The cash value is the feature that draws most attention, and the charges are the feature that deserves the most.  Each of the following affects the result more than any single year of index performance.

An IUL may fit if

• You need permanent coverage, not coverage for a limited period.
• You can commit to funding the policy for the long term.
• You value the flexibility of an adjustable premium.
• You are healthy enough to qualify medically.

An IUL may not fit if

• You need the most coverage for the lowest premium for a limited period.
• You may not be able to fund it consistently.
• You are looking for a guaranteed investment return.
• You expect to access the cash value in the first few years.

Five questions before you decide

• Show me the guaranteed and the non-guaranteed columns.  The illustration shows both.  Pay attention to the guaranteed column, which assumes the least favorable outcome the contract permits.  The non-guaranteed column usually assumes today’s cap continues.  The guaranteed column does not.
• What happens if credits are lower than illustrated? Ask for an illustration at a reduced rate, and see how much premium is needed to keep the policy in force.
• What is the crediting formula, and can it change? Review caps, participation rates, and spreads, and whether the carrier can adjust them.
• What are the surrender charges, and for how long? Know the cost of changing your mind in years one through ten.
• How would loans affect the death benefit? Ask to see an illustration that includes planned loans, and the point at which the policy could lapse.

Key takeaways

• An IUL is permanent life insurance with a flexible premium and index-linked cash value.
• The floor protects index credits from market losses, but charges and underfunding can still reduce value.
• Crediting formulas, charges, and surrender schedules differ by carrier, so compare more than one.
• An illustration is a scenario, not a promise.  Review the guaranteed column and a reduced-credit case.

If you want help reading an illustration, that conversation is complimentary and carries no obligation.  Call 317-900-6970 or start a conversation.  Meetings are by phone, video, or at your home.

About the Author

Ted Byrer, CAS®, is a Retirement Income Specialist and Independent Insurance Agent with Byrer Wealth Management, LLC in Westfield, Indiana.  Learn more at Ted Byrer.

This article is educational only.  It is not legal, tax, or investment advice, and it is not a recommendation or solicitation to buy any product.  Illustrations and examples are hypothetical, are not projections, and do not represent any specific policy.  Life insurance is issued by third-party insurance companies.  Guarantees rest solely on the claims-paying ability of the issuing company.  Index-linked credits cannot be below the contract’s stated minimum, but policy charges are deducted and can reduce cash value, and a policy that is underfunded can lapse.  Crediting methods, charges, underwriting, tax treatment, and availability vary by carrier, state, and contract.  Review any policy loan, withdrawal, or exchange with a tax professional first.  Insurance products are not FDIC insured and are not a deposit.  Ted Byrer is a licensed insurance professional, not a registered investment adviser, broker-dealer, or bank, and does not offer securities.  Byrer Wealth Management, LLC is an independent insurance agency and is compensated by commissions paid by insurance companies.