The Basics of Indexed Universal Life Insurance

Indexed universal life insurance gives you flexibility in your financial planning, and the ability to accumulate additional cash through your life insurance policy.

What Is Universal Life Insurance?

Universal life insurance is a form of permanent life insurance, which gives you death benefits without an expiration date as long as the policy stays in force. The death benefit can help to replace lost income or cover expenses after the insured has passed. You can even add a living benefits rider so that in the case of a qualifying medical event, such as chronic, critical, or terminal illness, you or your beneficiaries can access death benefits to pay those expenses.

Universal life insurance also gives you a cash value account that has the potential to accrue tax-deferred interest over time. If there is sufficient cash value, you can pay the annual cost of insurance from the cash value.  You can pay more than the annual cost of insurance.  You may also choose to withdraw from that cash value to cover personal expenses or work toward savings goals. Keep in mind, there may be tax consequences when withdrawing cash.

[content_band bg_color=”#e8f4f8″ border=”all”] [container] [custom_headline style=”margin: 0; 0; 0; 0;” type=”center” level=”h4″ looks_like=”h4″ accent=”true”]Key Takeaways[/custom_headline]

  • Indexed universal life insurance is one of the three basic types of universal life. It has a cash value element that grows based on the performance of a market index.
  • A market index measures the performance of related stocks. If the index related to your indexed universal life policy increases, the cash value of your policy can earn interest.
  • Any increase in cash value will depend not only on the performance of your index, but also on your policy’s participation rate, cap, and floor.
  • You can borrow against your accumulated cash value to pay personal expenses.[/container] [/content_band]

Cash Growth in Universal Life Insurance 

All forms of universal life insurance have cash values, but indexed universal life is unique in the way that cash value accrues.

  • Guaranteed universal life offers premium guarantees regardless of how the market indexes perform. Your plan’s interest rates are set into the premiums when you sign up for the policy and never change.
  • Variable universal life lets you choose investment vehicles for your cash value. This tends to be a more hands-on policy because you actively monitor the performance of your investments. In some cases, however, you can choose to have a fixed interest rate for your cash savings.
  • Indexed universal life also has an invested cash component. Instead of being tied to a particular investment product, however, it’s tied to a market index. Your interest rate goes up or down based on that index.

What Is a Market Index?

A market index tracks changes in the performance of the stock market. There are many market indexes out there, some measuring the performance of the market as a whole, others focusing on particular types of companies. The S&P 500, Dow Jones, and NASDAQ are just a few well-known indexes commonly available to indexed universal life policyholders.

Each index publishes a number that tells you whether its market is performing well or poorly. If the numbers in a particular index are trending up, the values of the stocks it represents are increasing. If the numbers are trending down, the values of the underlying stocks are dropping.

Market Index and Indexed Universal Life

Each indexed universal life policy follows a particular index, and insurers generally allow you to choose which index you want your policy to follow. It can help to know a bit about your options before selecting a plan, but don’t feel like you have to do all of the research on your own. You can always get in touch with an insurance professional to help you explore your options.

Regardless of which index your policy follows, most universal life policies are the same in the way they assess and credit interest.

How Interest Crediting Works

As an indexed universal life insurance policyholder, you pay a premium to your insurer. Part of that premium goes toward covering policy expenses. Once expenses are covered, the rest goes into your cash value account.

After a set period—usually a year—your insurer will calculate the change in your chosen index. You receive an interest credit based on the amount that the index shifts and on carrier-set variables like participation rates, caps, and floors. With an indexed universal life plan, you’re protected against losses if the market drops and you stand to benefit if the index value goes up.

Upside Potential

When the index associated with your policy increases, showing net growth, your account can earn interest credit. That interest credit gets added to your cash value account. The more good years your index has and the more it grows per year, the more your policy’s cash value can grow.

Downside Protection

Investors in the open market face losses if the market drops. Indexed universal life is an insurance product, so it safeguards against such losses using interest floors. Some accounts have 0% floors, meaning that you aren’t guaranteed any gain, but you’re also completely protected from losses. Others have 1% to 2% floors that guarantee at least that percentage of interest credit.

For example, assume you have a floor of 1% on your indexed universal life insurance policy. If you had a stock market investment instead of a policy, you would likely have lost money when coronavirus caused the stock markets to plummet in March of 2020. Your indexed universal life insurance policy, however, keeps you protected from a loss associated with the mirrored index and guarantees at least a 1% gain on your cash-value account.

Using Your Policy’s Cash Value

Growing the cash value of your life insurance policy has several benefits. With an indexed universal life insurance policy, you have the option of withdrawing from your policy’s cash value to cover personal expenses. That means your cash value account can serve as an attractive supplement to your retirement income, as the policy has several cash withdrawal options, some can even be tax-advantaged.

Many index universal policies also allow you to choose an increasing death benefit option, in which your death benefit payout increases as the cash value of your policy grows. In some situations, you can choose to decrease your death benefit as well, directing a greater percentage of your premiums toward building cash value.