The pros and cons of indexed universal life insurance (IUL) can be difficult to make sense of, especially if you are not familiar with how life insurance works. While IUL is one of the hottest products on the market, it’s also one of the most volatile. There are very few people whom we would advise to buy an indexed universal life policy.
In this article, we’ll start with the potential upside in IUL before transitioning into why it’s so dangerous.
Quick Article Guide:
To put it simply, IUL is a type of permanent life insurance (meaning it provides coverage for your entire life) that 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 idea 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.
Investopedia explains that the allure of IUL is in “the potential for healthy gains in the cash value—gains that can be significantly higher than those possible on many other types of financial products, including traditional universal life or whole life insurance policies.” They also add that the crediting “floor,” or the minimum percentage the policy will be credited, provides a layer of protection in the case of a market crash that you would not have if you were fully invested in the stock market. If you have a negative return, you will not have a negative crediting rate. Instead, the rate will usually be 0 or 1 percent.
Additionally, Investopedia lists tax advantages in their benefits of IUL, as the death benefit (money paid to your beneficiaries after you die) is tax-free. This is true, but we will add that it is also the case in any life insurance policy, not just IUL. The same goes for their mentioning of the many riders available. These add-ons can be purchased for other types of policies, such as term life insurance and non-guaranteed universal life insurance.
The one thing you need to know about indexed universal life insurance is that there is a very real market risk involved. Investing with life insurance is a different game than buying life insurance to protect your family, and one that’s not for the faint of heart. At our independent agency, we usually advise only the ultra-wealthy—those making $300k per year or more—to even consider investing with life insurance, and even then, most find that they would rather play it safe with their life insurance.
Life insurance agents will sell the upside of investing with a cash accumulating policy. Particularly with IUL, they’ll say things like:
- “You can send your kids to college on it.”
- “You can borrow from it.”
- “You can retire on it.”
- “It’s a no-brainer.”
These are the same types of promises that got people into trouble with standard universal life insurance during the 1980s. InvestmentNews explains the dangers of IUL:
“Advisers need to bear in mind that IUL comes with certain risks. For instance, all UL products and any general account product that depends on the performance of insurers’ bond portfolios will be subject to interest rate risk.”
“There are inherent dangers with leading clients to believe they’ll have high rates of return on this product. For instance, a client might slack off on funding the cash value, and if the policy doesn’t perform as expected, this could lead to a lapse in coverage. Another danger: What if a client is taking policy loans from the cash value and paying interest, but the policy underperforms and the interest credited doesn’t cover the costs of the loan?
That leads us to the most critical risk factor in IUL: the effects of an underperforming policy. 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.
The financial risk is compounded by the fact that this can all happen without you realizing until it’s too late, in which case you might find yourself both unable to pay your premium and unable to secure new coverage.
Investopedia adds that the fees that come with an IUL policy can be hefty upfront including a premium expense charge, administrative expense fee, insurance costs, fees and commissions and surrender charge. IUL policies are expensive to buy and expensive to manage, with returns that Investopedia says can be “lower than policyholders are encouraged to anticipate.”
Indexed universal life insurance is becoming notorious for being exaggerated and even misrepresented by insurance agents. In 2014, the State of New York’s insurance regulator probed 134 insurers on how they market such policies out of concern that they were exaggerating the potential gains to consumers. After continued scrutiny, IUL was hit in 2015 with regulations that the Wall Street Journal called, “A Dose of Reality for a Hot-Selling Insurance Product.”
If you come across an agent who is strongly advocating for IUL without knowing your needs, it’s best to seek assistance elsewhere. IUL is not designed for the novice or even middle class investor, nor is it for the faint of heart. Can you handle seeing the stock index perform poorly knowing that it directly affects your life insurance and your ability to protect your family? This is the final gut check that deters even extremely wealthy investors from IUL.
The whole point of buying life insurance is to reduce risk, not create it. For that reason, we usually recommend clients to move away from IUL and toward the safe bets in life insurance:
“Buy Term and Invest the Difference.”
If you are relatively young and can afford life insurance, consider following the age-old mantra, “Buy term and invest the difference.” This saying refers to term life insurance, which offers guaranteed coverage for a set number of years, at a much lower cost than universal life insurance. With a term life policy to protect your family and money left over that you would have poured into a risky IUL, you can invest in stocks, bonds, or mutual funds. The Motley Fool explains:
“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.”
Term life offers the following benefits:
- 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
This type of coverage is great for someone looking to insure their family for a mortgage, children’s college tuition, or income loss protection. Learn more about term life here.
Guaranteed Universal Life Insurance
If you are looking for a policy to last your entire life, take a look at guaranteed universal life insurance (GUL). A GUL policy is not technically permanent life insurance, but rather a hybrid between term life and universal life that can enable you to leave a legacy behind, tax-free. Most clients in their 50s and 60s choose GUL over term life because GUL lasts up to a specific age—rather than a set number of years—that can be well into their 100s.
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.
For an in-depth comparison between non-guaranteed and guaranteed universal life insurance, click here.
JRC Insurance Group is here to help you find the right policy for your needs, with no extra cost or fee for our assistance. Our purpose as an independent life insurance agency is to shop the market on our customers’ behalf so they do not have to try to Google their way to a decision they are unsure of.
We can retrieve quotes from 40 top-rated carriers, allowing you to look beyond the big-box companies that often overcharge. Get started now and call us toll-free at 855-247-9555. No sales pitches. No pressure. No obligations. Consider us a friend in the insurance industry who will look out for your best interests.
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