Indexed Universal Life Insurance policies are popular. Oftentimes, they are presented as risk-less investments. However, there are many details and moving parts to keep in mind. Those looking to purchase one without careful review and understanding of the insurance product could be exposed to greater risks than originally anticipated.
Thinking about buying an IUL? Pause for reflection! This post will cover some of the basics and help get you started. It presents some of the facets you should consider as a starting place. I also recommend you go even further to understand your financial situation with your certified, tenured, trustworthy and proven, financial professional (i.e. not the insurance agent trying to sell it to you) before transacting.
WHAT IS AN INDEXED UNIVERSAL LIFE (IUL) INSURANCE POLICY? HOW DOES IT WORK?
Table of Contents
IULs belong to the Universal Life family of insurance policies. They are highly nuanced and operate with various factors which certainly provide myriad options for the experienced investor.
They are popular, but to an unexperienced investor they can be risky! This blog post is about exploring some fundamentals, examining IULs, and developing Mêtis in our Money Matters.
I will lead-off by saying that I am generally not a fan of these policies for reasons I will outline below. This is just my opinion, and they may well be a great fit for a unique situation. First, one should understand what they are truly paying for. I am concerned that illustrative promises may motivate buyers under false pretenses (I’ll share later in this post, my concerns are not ill-founded).
That said, they are not “evil” instruments, and they could serve someone of high net worth quite well. In those situations, I could see how that type of individual may benefit well as part of a diversified plan. In the same way, I am not trying to paint all insurance agents as minions. Certainly, they are an essential and helpful asset to one’s financial plan.
Understanding an Indexed Universal Life Insurance Policy
IULs (Indexed Universal Life) are part of the Universal Life Insurance, or permanent insurance, flavor of the life insurance family (contrast this against Term Life Insurance which has a fixed ‘term’ of Insurance). They also include a cash value component.
Universal life insurance policies allow a lot of customization. This includes ‘fixed’ or ‘variable’ features (such as premiums and death benefits). In the case of an IUL, it can be linked to a varying degree of underlying indices which drive the Cash Value. Common examples include the S&P 500. The Cash Value component adds another whole attribute which we’ll cover more, below.
Cash Value
The Cash value is part of what your premium goes toward. An IUL links to an underlying index. Exposure to this index is partially what drives your return. This is another place where it is very important to understand what you are buying; there are a lot of very important and critical details.
Here are a few more concepts and examples.
Make sure to read your policy very carefully! Understand the fees.
- Part of it immediately goes to paying expenses, charges, or fees (there are also potentially fees that are charged after the fact as well)
- With the remainder then going toward your cash value
- Then, monthly charges such as mortality charges are subtracted from your cash value to pay for your death benefit.
- Credits or “additions” to your cash value account (let’s generally call this “interest”) go into your account, increasing it in value. IULs will generally use some sort of reference index to credit value accordingly. This interest could be credited monthly or annually, etc. It depends on the details. Additionally, the interest rate could change over time.
- Loans and withdrawals you take out could also lower the cash value.
Indexed Account
Make sure to understand which index the account links to. Just because it looks like a common term doesn’t mean anything per se. This flexibility is a strength and could offer some great targeted exposure. However, it can also hurt. Read the policy, and get comfortable with your understanding of the underlying index.
Floors and Ceilings
These can be called different names, but the essence is to understand what minimums (floors) and what maximums (caps) you should expect. IULs offer a lot of flexibility, but the downside is that you could miss on the upside of the markets. These thresholds are different depending on the policy. Get a good feel for what boundaries you are agreeing to in your policy; check to understand if the cap or floor can change over time.
Participation Rate
After understanding those pieces, take a moment to make sure you understand the actual participation rate. Your policy could be linked to an index such as the S&P 500. However, your terms may only allow you to participate in a smaller percentage of the total movement in the market (of course, keeping in mind the capped rate we talked about previously). This is also very important to understand.
INDEXED UNIVERSAL LIFE (IUL) POLICIES: PROS AND CONS
These insurance products are complicated and advanced. They offer a lot of good flexibility, and they can be helpful for a specific need. However, they bring with that flexibility an increase in risk as well. Investors would be wise to consider, research, and weigh that risk carefully before taking the plunge!
PROS for the Indexed Universal Life Policy
As I said, they offer a lot of options and have various riders available for your needs. This is certainly good! They are also a permanent life insurance. This means they will pay out a death benefit (provided the premiums are paid, etc.). Additionally, they offer tax-deferred growth (similar to the Roth IRA) which means the after-tax dollars you pay-in grow in a tax-efficient manner. Also, should you chose to take out a loan against the cash value, you have that option. Carefully consider the options before moving forward.
CONS of the Indexed Universal Life (IUL) Policy
We talked about the options of the policy, a strength, but this can also be dangerous if you are unsure of the details in the contract.
Take care to mind the index! Ensure you’re linked to an index that makes sense for your investment needs. Check-in, and see how your IUL handles stock dividends. Dividends from the underlying stock index may not be credited to your cash value account.
Watch the details of the terms we discussed above. Namely, the floors, ceilings, and participation rates. Also, keep in mind that your policy premium could be setup to increase over time. Not a bad thing per se, but one that you should carefully consider.
I have also read of cases where the cash values are depleted to cover downturns when the costs of the insurance are greater than the premium payment going into the policy. Another detail to understand.
Is an Indexed Universal Life Insurance (IUL) policy a good investment?
In short, be careful, very careful, and avoid the agent selling your the policy under the pretense of “this is what the rich are doing” or “it’s an obvious move to make”, or “you can setup your kid’s college fund with this”, etc. These statements are likely aimed at your emotions, and by themselves are not good reasons to do anything; they are simply hooks to pull you in. Avoid the scams, and use financial logic that fits YOUR situation.
When at all possible, I highly recommend you consult with a well-trusted, certified (e.g. CPA, and or tax attorney), fiduciary, and/or fee-based (avoid sales commissions) financial professional, who understands YOUR unique financial situation before moving forward. My friend, please hear my concern, and don’t blindly take the word of the insurance agent selling to you.
Beware of the false advertising in the “charts” and advertised returns. Look out for the overly optimistic returns and “illustrations” they brandish. Make sure you understand what is being presented, and do your homework. I have found that the NAIC (the regulatory body) has been working through ways to protect consumers looking to buy Indexed Universal Life policies. In my opinion, this is only a minimum at best and consumers should always consult their trusted advisor.
Mêtis in our Life Insurance Matters
Personally, the IUL is not for me. Instead, I prefer to utilize Insurance for what it is: insurance. For me, it is there to address a risk. In this case, I do that with a combination of a Term policy and insurance from my employer. Additionally, a steady cost-averaging approach through my Roth retirement tools, and a broad diversification of my investment choices works well for my family.
This combined approach allows for natural hedging against inflation and certain risks. Additionally, I will say that when the stock market drops I view the opportunity as a great time to buy more, increase my holdings, and otherwise position myself financially.
All that said, maybe if I strike it rich one day and cannot find other investments, I would consider the IUL at that time.
My opinion is always strongly biased toward everyday finances for the everyday family. My friend, I hope this post serves to present some food for thought!
Leave a Reply