What is Indexed Universal Life Insurance?
By Joe Globensky, RFC®
As part of our initiative to educate our clients and prospective clients, we often check out what is trending on social media. What products or solutions are people searching for? What industry terms do people want to know more about? In a recent probe, we discovered many were searching, “What is Indexed Universal Life Insurance?” So, let’s talk about what it is, the benefits, the downsides, and who it may be right for.
What is Indexed Universal Life Insurance?
Life insurance provides beneficiaries with a payment of a pre-determined death benefit upon the insured’s death. It’s a way to help protect beneficiaries after the insured passes away, especially if they are still financially dependent on the insured at the time of their passing. But there are many types of life insurance, including Indexed Universal Life (IUL).
An IUL policy provides a guaranteed death benefit, but it also has a cash value that can be used to pay policy premiums or take withdrawals or loans against the policy. In an IUL policy, this cash value is tied to the performance of a market index like the S&P 500. Unlike investing directly in an S&P 500 index fund though, in an IUL policy you won’t lose money when the market has a downturn. This is because the IUL policy comes with a guarantee insuring against losses of your principal. However, there’s usually a cap on the maximum return you can earn.
The Benefits of Indexed Universal Life Insurance
One of the most attractive features of an IUL policy is the ability to take advantage of stock market returns without the risk of loss. In addition, while traditional retirement accounts have contribution limits, IULs do not. Also, with most retirement programs, you must wait until you turn 59 ½ before taking distributions, otherwise you may be penalized. With an IUL policy, there is no age requirement.
IUL distributions are tax-free vs. tax-deferred with most other retirement vehicles. That means you don’t have to pay taxes on the money you eventually draw from the cash value of the IUL. It’s similar to a Roth IRA in this respect. Also, the death benefit is tax-free when distributed to your beneficiaries, which means it won’t face income taxes, or estate taxes if properly structured.
The Downsides of Indexed Universal Life Insurance
Like any financial product, there are some drawbacks that might hold you back from investing in an IUL. Critics point to high fees associated with permanent life insurance like IUL. By contrast, a retirement account, especially one invested in low-cost investments, will lose significantly less to fees.
Someone seeking both life insurance and tax-free retirement distributions might be better off getting a term life policy and opening a Roth IRA, rather than trying to combine the benefits into one product.
Other downsides include an earnings cap on the index or indices you use inside the IUL. If the market is having a particularly good year, your earnings may be less than investing directly in a low-cost index fund. And, if your policy ever lapses or is surrendered, any money you’ve taken out may be taxable.
Is Indexed Universal Life Insurance a Good Fit for You?
It’s not a simple yes or no answer. First, do you have a need for life insurance? If not, and you’ve read this far, at least now you’ve answered the question, “What is Indexed Universal Life insurance?”
Have you maxed out all your other retirement savings options? One of the most common uses for IUL policies is additional retirement savings. If you are maxing out your employer-sponsored retirement plan, as well as a traditional or Roth IRA, an IUL policy may be worth a look. If you’re not maxing them out now, maybe hold off on an IUL policy until you are.
And make sure you take a long-term view when deciding on an IUL policy. The policies are designed as long-term vehicles and you shouldn’t plan on taking any money from it for at least 10 years or longer.
At Connections Financial Advisors, we believe in educating our clients so they can make more informed decisions to better their financial position and reduce their financial stress. If you would like to learn more about our firm, or you’re ready to schedule a complimentary initial meeting, please give us a call at (217) 605-8130 or send us an e-mail.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
All guarantees and benefits of the insurance policy are backed by the claims-paying ability of the issuing insurance company.
Both loans and withdrawals from a permanent life insurance policy may be subject to penalties and fees and, along with any accrued loan interest, will reduce the policy’s account value and death benefit. Withdrawals are taxed only to the extent that they exceed the policy owner’s cost basis in the policy and usually loans are free from current federal taxation. A policy loan could result in tax consequences if the policy lapses or is surrendered while a loan is outstanding.
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