Indexed universal life insurance (IUL) is tied to a stock market index, such as the S&P 500. The stock market provides a benchmark for which the IUL policyholder’s cash accumulation account is credited. With IUL, you are “participating” in a stock market index, with maximum and minimum percentages on your return. The hope is that over time, you will see a higher return than you would with a traditional universal life policy, which only credits using the insurance company’s benchmarks rather than the stock market.
While IUL might seem like an exciting investment, the truth is that it is not the right product for most people.
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While IUL can conceivably yield higher returns than other types of life insurance, that prospect comes with a proportionally elevated risk. Despite being immortalized by many life insurance agents, IUL has the potential to not only flop, but perhaps even put you in a position where you are left without life insurance altogether.
The cost of insurance is not fixed in a policy that builds cash such as IUL, meaning it’s entirely possible that your cash accumulation account could eventually dry up if either or both of the following occur:
- The index your policy is linked to does not perform well over an extended period of time.
- The cost of your premium (which increases with each year you age) exceeds your cash accumulation income.
Even worse, this can easily happen under the radar over the course of years. By the time you realize your cash value is gone and you can no longer afford the policy, you might have a difficult time qualifying for a new policy that provides the protection you need. Bank on Yourself writes:
“Indexed Universal Life insurance policies shift all the burden and risk of managing the policy from the insurance company to you, the policy owner. The insurance company gets its money, but you don’t necessarily get yours. You might very well find yourself having to pay skyrocketing premiums, just to keep the policy from lapsing—or risk losing everything you’ve paid into the policy over the years.”
With the risk understood, let’s get into the types of buyers who should not buy an IUL policy.
1. Novice Investors
We typically only recommend IUL to ultra-wealthy, experienced investors who have maxed out all other investment vehicles. Our reason is that IUL has a high likelihood of failure in today’s volatile market and does not yield the type of return that other investments will when the market does perform well. The Motley Fool echoes our advice:
“Before buying complicated insurance products like universal and indexed universal life insurance, make sure you’re taking full advantage of other tax-deferred investing alternatives such as traditional or Roth IRAs, combined with stand-alone term life insurance first. For most people, this will be a more affordable choice and potentially a better long-term value.”
2. The Faint-Hearted
Can you handle watching the stock index perform poorly, knowing that your ability to protect your family is at stake? Even advanced investors tend to move away from IUL when they realize they’re essentially gambling with their life insurance.
Instead of rolling the dice, you could buy term life insurance or guaranteed universal life insurance and have complete peace of mind, knowing that your policy is not tied to stocks.
3. Those Who Would Feel a Missed Paycheck
Bank on Yourself calls IUL “a ticking time bomb,” drawing attention to the many fees that can destine your policy for failure. These costs include premium expense charges, administrative expense fees, insurance costs, fees, and commissions, and surrender charges if you wish to cancel your policy.
We’ll reiterate the importance of having significant, reliable income if you’re going to buy and maintain an IUL policy. We’re talking $300k per year or more, with a large savings account to match. If you are in a bubble market, or if your income could drop substantially, IUL is not the type of investment you want to be making. Needless to say, if you are earning a moderate income with moderate savings, you should not be investing with an indexed universal life policy.
4. Homeowners Paying off a Mortgage
Many people buy life insurance solely to protect a surviving spouse from being left without a way to pay their mortgage. The best type of coverage for this specific case is called term life insurance. With term life insurance, you are paying only for protection—no bells and whistles, no cash accumulation, nothing to worry about. Term life policies provide coverage for a set period of time and pay a death benefit to the beneficiary if the insured dies during the term.
The benefits of term life insurance are:
- Affordable coverage
- Flexible options
- A fixed rate for a set period of time
- No startup costs
- No surrender charge
- No hidden fees
- The freedom to cancel or change your policy at any time
Learn more about term life here.
Insuring the cost of raising a child and sending them to college is another use case for term life insurance. Most term policies are convertible, meaning you have the option to turn the policy into permanent coverage without having to re-qualify.
You can also use a strategy called term layering, or term laddering, to stack two or more term life insurance policies and cover all bases.
For example, let’s say Bob is 35 years old and married with two children, ages 2 and 5. For the next 20 years, Bob will want to have the most coverage possible until the kids are grown and able to take care of themselves. He has a 30-year mortgage, so a 20-year term policy would leave a 10-year lapse in mortgage protection. At the same time, he also doesn’t need maximum coverage for a full 30-year term, because after 20 years, his children will hopefully be self-sufficient, and he’ll need less life insurance.
To meet both of his needs, Bob buys two term life insurance policies, one for 20 years and one for 30 years, each with a $500,000 death benefit. This also allows him to lock in 30 years of coverage while he is in good health and able to get preferred rates. After Bob’s 20-year policy expires, he will shed that policy’s monthly premium while still having the 30-year policy to mirror the mortgage. When the 30-year policy expires, he can renew his policy, convert it to a permanent policy, or buy a new policy altogether, based on his needs.
With an independent agent like JRC guiding you through your life insurance search, you can be more strategic about your future instead of adding risk. Remember, the whole point of life insurance is to protect your family.
Getting approved for life insurance in your 60s and 70s can be challenging. You want a policy that will last your entire life but is still affordable. The last thing you want is a high-risk investment that could leave you without life insurance in your latter years.
Guaranteed universal life insurance (GUL) can be the perfect middle ground between the simplicity of term life and the lifelong coverage of permanent life insurance. Most clients in their 50s and 60s gravitate to GUL because it lasts up to a specific age that can be well into their 100s, with no investment—and thus, no risk—involved.
The benefits of GUL are:
- Your cost of insurance will not change, even as you get older or if your health changes.
- Your coverage isn’t tied to an investment. You pay for the life insurance protection only, just like term life insurance.
- You aren’t pouring extra money into your policy. Trust the financial experts on this: you’re better off putting your money into a savings or perhaps paying down your mortgage.
- You will pay less up front. Guaranteed universal life insurance is a fraction of the cost of non-guaranteed universal life.
- You don’t run the risk of losing coverage from unfavorable investments or changes in the market.
Learn more about GUL here.
The unfortunate truth about IUL is that many agents are selling it for the commission. In fact, the State of New York’s insurance regulator probed 134 insurers in 2014 to examine how they market such policies. This was out of concern that agents were exaggerating the potential gains to consumers.
At JRC, our only job is to help you find the life insurance that’s right for your needs, regardless of the company or product. Being an independent agency allows us to work with 45+ top-rated insurers, with no sales quotas and no cost to you for our services.
If indexed universal life insurance truly suits your needs, we will gladly help you secure the IUL policy you’re looking for. But more often than not, clients who were considering IUL thank us for leading them to a safer policy. Contact us toll-free at 855-247-9555 for life insurance, simplified.
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