Indexed universal life insurance (IUL) is a hot product on the market, but many consumers do not understand the risk associated with owning an IUL policy. Clients come to us every day asking whether or not they should purchase IUL as an investment to add to their portfolio. When we explain to them how IUL works, they begin to realize it is not the no-brainer investment that a sales-focused agent might insist.
Read on as we bring the buzz about IUL back down to Earth so that you can make an informed decision on whether or not to buy this relatively new life insurance product.
Quick Article Guide:
1. What Is Indexed Universal Life Insurance?
2. Pros and Cons of Indexed Universal Life Insurance
3. Expectations vs. Reality
4. Who Should Buy IUL?
5. What Are the Other Options?
6. Your Insurance Agent Should Also Be Your Advocate
In simplest terms, an indexed universal life policy 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. InvestmentNews likens IUL to “a cousin of traditional universal life insurance coverage, permanent life insurance that permits clients to pay flexible premiums,” adding, “Unlike variable universal life insurance, clients aren’t directly investing in the market. Rather, their cash value reflects the performance of an index subject to caps and floors.”
With IUL, you are basically “participating” in a stock market index, with maximum and minimum percentages on your return. The hope is that over time, the policyholder sees a higher return than they would with a traditional universal life policy, which only credits using the insurance company’s benchmarks rather than the stock market. Meanwhile, the “floor” percentage provides some protection in the case of poor performance.
IUL creates some complexity in terms of the benefits and drawbacks. Here is a plain-and-simple list to help you weigh both sides:
- Cash value growth is tax-deferred
- Higher return potential compared to other universal life and whole life policies
- High degree of policy flexibility and customization
- Lower risk than actually investing in the stock market
- Capital gains are tax-free
- Tax-free borrowing from cash accumulation
- Poor performance can negate contributions and dwindle cash value down to zero
- Many variables subject to change by the insurance company
- Maximum “participation rates” are typically well below 100 percent (cap on returns)
- No dividends, just a credit to your account
- Loans from cash accumulation are subject to interest
- The policy is not guaranteed, meaning the investment can flop and the policy can become unaffordable
- * The Nelson Nast Institute elaborates on IUL drawbacks in an article titled, “The Top 10 Reasons Not to Buy Equity Indexed Universal Life Insurance.”
IUL is frequently immortalized by agents. They might say things like:
- “You can borrow from it.”
- “You can use the return to send your kids to college.”
- “You can retire on it.”
- “You can’t lose.”
What these agents won’t always tell you is that IUL poses a huge risk to the policyholder. In fact, 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.”
The problem isn’t necessarily that life insurance is a bad investment; it’s that most people don’t understand that it is an investment. Life insurance agents, naturally, will sell the upside of investing with a cash accumulating policy such as IUL. They’re not necessarily doing anything blatantly unethical by downplaying the dangers, but their sales pitches can sometimes lull consumers into false assumptions. Typically, they hinge their advice to what’s called the non-guaranteed assumption to show the potential for return. Unfortunately, it’s the guaranteed assumption that is usually closer to reality.
If you take away one point from this article, let it be this: When investing with life insurance, there is always a risk involved. The cost of insurance is not fixed in a policy that builds cash, meaning it’s entirely possible that your cash accumulation account could eventually dry up if the index your policy is linked to does not perform over an extended period of time and/or the cost of your premium (which increases with each year you age) exceeds your cash accumulation income.
Also note that in any cash accumulating policy, you will usually have to “overfund” the policy on the front end in order to offset the annual cost of insurance increase. You will also pay interest on the money you borrow.
And remember, the cash value is not a death benefit. When you die, your beneficiary will not see that money.
For the general population of working class Americans, life insurance is not a sound investment. IUL, in particular, is not for novice investors. It is very complex, and very involved. It’s also not for the faint of heart, or those who have difficulty relinquishing control of their investments’ performance. The Motley Fool echoes our advice, writing:
“Universal life insurance plans, including indexed universal life, frankly, aren’t good choices for the vast majority of people. There are some tax benefits, but they are almost only of real value for high-wealth/high-income earners or business owners, and often come at too high a cost with too low of potential returns for the tax benefits they provide.”
If you are going to go through with buying an IUL policy, you should be able to answer, “yes” to all of the following questions:
Are you making at least $250k per year?
At our independent agency, we typically only advise the ultra-wealthy to consider investing with life insurance, mainly as a tax shelter. Even then, many experts will still tell you to steer clear.
Is your income stable at that level?
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. It is very expensive, with many variables and a high level of risk.
Are you maxing out all of your other investment options?
The Motley Fool advises:
“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.”
Do you have a high risk tolerance?
Can you handle seeing the stock index perform poorly knowing that it directly affects your life insurance and your ability to protect you family from financial hardship after you die? This is the final gut check that deters even extremely wealthy investors from IUL.
If you answered, “no” to any of the questions in the previous section, there are two main options we want you to know about. We share these having helped many clients avoid the pitfalls of IUL and secure simpler coverage, at a better rate, with no risk.
Buy Term and Invest the Difference
Instead of investing with universal life, many financial experts will repeat 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.
When you buy term life insurance, you can take the money that you would have been investing in universal life and put it toward a more straightforward investment, such as stocks, bonds, or mutual funds.
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
Term life insurance is ideal for those who are 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
At JRC, we are strong proponents for the risk-free counterpart to IUL: guaranteed universal life insurance (GUL). A GUL policy is 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.
If you are considering purchasing indexed universal life insurance—or any type of life insurance, for that matter—it’s important that you have an expert on your side to provide objective, knowledgeable advice.
At JRC Insurance Group, we pride ourselves on being advocates for our clients’ best interests. We do not impose sales quotas on our team, nor do we hold clients to obligations involving our assistance. We’re here strictly to help you find the best life insurance coverage for your needs, at the best rate available on the market. Click the button below to get a free quote today, or give us a call, toll-free at: 855-247-9555
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