Today, I’m going to go off the beaten path for myself and discuss the pros and cons of buying indexed universal life insurance. As a fee-only advisor, I do not sell any insurance or commission-based products. However, on several occasions, I have received requests from customers to review their existing insurance coverage. I certainly don’t know every IUL product out there. And maybe I am missing some nuances and differences between them. My observation is that the IUL is not suitable for the average person due to its complexity and high cost. And yet, IUL may be the right product for you if you can take advantage of the benefits it has to offer.
What is an Indexed Universal Life Insurance (IUL)?
Indexed Universal Life is a popular insurance product that promises stock market-like performance and protection coverage with zero-downside risk. Like other universal life insurance, IUL offers a death benefit and cash value. Your cash value account may earn interest based on the performance of specific stock market indexes such as the S&P 500, Dow Jones Industrial Average, Nasdaq 100 and Russell 2000.
IUL depilation spleen
IUL policies use an illustrative rate for advertising and hypothetically project policy values in their sales materials. The instance rate is the fixed rate derived from historical performance. Typically, the delineation rate is between 5% and 10%.
Is the IUL Right for Me?
On the surface, indexed Universal Life Insurance sounds like a great deal. You get a stock market upside with zero risk for loss. Still, the IUL comes with some serious caveats.
Let’s break down the main benefits and drawbacks of IULs.
Benefits of Indexed Universal Life Insurance
Index Universal Life Insurance allows you to increase the cash value and death benefit of your policy on a tax-deferred basis. Generally, you won’t have to pay income tax on your cash value and interest accrued in the death benefit.
tax free distribution
Life insurance, in general, is an attractive tool for legacy planning. With IUL, your policy beneficiaries will get the death benefit tax free. As long as you maintain your insurance premiums and don’t take massive loans, you can pass the money to the next generation tax-free.
access to cash value
You can always avail the base (basic premium paid) of your policy tax-free. In most cases, you can also access your cash value through a tax-advantaged policy loan or withdrawal. In an emergency, you can borrow from your indexed universal life insurance policy. You can access your cash value without any penalty regardless of your age.
supplemental retirement income
You can use the cash value from your policy as a source of supplemental retirement income. You can also use it to cover future medical expenses.
limited downside risk
IUL provides protection against stock market volatility. An IUL provides the benefits associated with the stock market without the risk of losing the principal due to a downturn in the stock market. With IUL’s principal-protection guarantee, your annual benefits are locked in. Your principal cash value remains the same even if the stock market goes down.
a guaranteed lowest rate
Many IUL policies come with a guaranteed minimum annual interest rate. This rate is a floor of how much you can earn each year. Guaranteed allows you to get a certain percentage regardless of how the market performs. This minimum rate depends on the specific insurance, and can vary between 0% and 2%.
Drawbacks of Indexed Universal Life Insurance
IUL is complicated
IUL is a very complex insurance product, There are many dynamic parts to your UIL policy, which make it confusing and difficult to understand. Most sales illustration packages illustrate a perfect scenario with non-guaranteed average market performance figures. In fact, between your annual premium, cap rate, floor, fees, market returns, cash value accumulation, riders, etc., it is difficult to predict the outcome of your insurance benefits.
Those who sell IULs are highly trained sales professionals who may not be qualified to provide financial advice. IULs come with a hefty upfront commission, which is often hammered into the fine print and deducted from your first premium payment.
IUL has high fees
The policy fee will stun you and literally eat up your lunch. I’ve personally seen fees in the neighborhood of 11% to 13% a year. These charges will always reduce the benefits of your annual premium and accrued interest.
limited earning potential
IUL policies will generally limit your stock market returns and exclude all dividends. Most IULs offer some combination of a participation rate and a limited rate, compared to the example rate used in their marketing materials.
participation rate is Percentage of positive index movement credited to the policy. For example, if the S&P 500 has grown by 10% and the IUL has an annual participation rate of 50%, your policy will receive 5% interest on the anniversary date.
cap rate That is the maximum rate you can earn annually, The cap rate can vary significantly from policy to policy and from insurance provider to the next.
Why is capped upside an issue?
The problem with cap rates and participation rates is that they limit your gains, especially during good years. Historically, stock market returns have not been linear and sequential, as shown by policy illustration rates. The stock market earned an average of 11.27% per annum in the 40 years between 1980 and 2019. During this period, there were only eight years when the stock market had negative returns, or 20% of that period. There were only seven years when the stock market posted returns between 0% and 10%. And there were also 25 years when the stock market gained more than 10% per year. In 17 of those 25 periods, stock market investors gained 20% or more than 42% of the time.
In other words, historically, the potential for massive gains has been much greater than the potential for losses.
However, as humans, the pain of losing money is stronger than the joy of gaining.
In effect, long-term IUL policyholders will give up their ability to earn these external profits to reduce their anxiety and the stress of losing money.
IULs attract heavy surrender charges. If you change your mind in a few years and decide to cancel your policy, you may not be able to get the full cash value. Before entering into a contract, please find out when the surrender charges expire.
Indexed Universal Life Insurance usually offers riders. Policy riders are contract add-ons that offer special benefits in exchange for additional charges. These provisions can include long-term care services, disability waiver, improved performance, children’s term insurance, no-lapse guarantee, and more. The additional charge for each rider will reduce your cash value at the same rate as the regular policy fee. You need to assess each rider individually as the cumulative cost may exceed your benefit and vice versa,
Cash Value Withdrawals Lower Your Death Benefit
In most cases, you may be able to make a tax-free withdrawal from the cash value of your IUL policy. These withdrawals are often treated as loans. However, old-minded policyholders need to remember that withdrawing your cash value reduces your beneficiaries’ death benefit when you die.
potential taxable income
There is still a chance to pay taxes on your IUL policy. If you let your policy lapse or decide to surrender it, the amount you withdraw earlier may be taxable. Withdrawals are considered taxable when they exceed your original cost basis or premiums paid.
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