Indexed universal life (IUL) insurance is a type of permanent life insurance that combines a death benefit with a cash value component, allowing policyholders to grow their savings based on the performance of a market index. IUL policies are inherently complex, offering flexibility in premium payments and the ability to adjust death benefits to match changing life circumstances. Bankrate’s insurance editorial team is committed to helping you make informed financial decisions. This guide will cover the essentials of indexed universal life insurance to help you decide if it’s the right choice for your needs.

Indexed universal life (IUL) insurance is a type of permanent life insurance that includes both a death benefit and a cash value component. The cash value grows based on the performance of a selected market index, such as the S&P 500 or Nasdaq Composite.

Each premium payment you make is divided into two parts. One portion goes toward maintaining the death benefit, providing financial protection to your beneficiaries. The other portion is allocated to the cash value, which earns interest based on the linked index. Depending on your premium payment structure and the age of your policy, the allocation between maintaining the policy and building cash value can vary.

IUL policies typically include a minimum guaranteed crediting rate to protect against market downturns, although they also have a cap on the maximum returns you can earn.

Designed to provide lifetime coverage, permanent life insurance policies like IUL generally have a maximum coverage age ranging from 95 to 121, depending on the policy, as long as premiums are paid. As the cash value builds, you can borrow against it, but unpaid loans will reduce the death benefit. Alternatively, you can make withdrawals from the cash value without repaying them, although this also reduces the death benefit.

IUL policies offer flexibility in premium payments and death benefits, allowing for adjustments based on the accumulated cash value and providing adaptable financial planning options. We’ll explore these features in more detail below.

IUL policies offer flexibility and the potential for growth through market-linked returns. They provide lifelong coverage, as long as premiums are paid, and include a cash value component that grows based on a market index, such as the S&P 500. Understanding how IUL policies work can help you determine if this type of insurance aligns with your financial goals.

The cash value component of an IUL policy is a key feature that sets it apart from other life insurance types. The policy’s cash value grows based on the performance of a selected market index. However, IUL policies typically include a “cap,” “floor,” and participation rate.

Cap: This is the maximum interest rate your policy can earn, even if the index performs better. For example, if the cap is 10 percent and the index gains 12 percent, your earnings will be limited to the 10 percent cap.

Floor: This is the minimum interest rate your policy is guaranteed to earn, protecting your cash value from market downturns. Even if the index performs poorly, your cash value won’t drop below the floor rate, which is often set at 0 percent.

Participation Rate: This rate dictates how much of the return is credited to the policyholder. While it’s usually 100%, the insurance company can lower it. For example, with a 10% cap and an 80% participation rate, the policy would be credited with an 8% return rate.

Once your IUL policy has accumulated sufficient cash value, you can access these funds through loans or withdrawals:

Loans: You can borrow against your policy’s cash value at relatively low interest rates for any reason. Insurers will typically lower the crediting interest rate on the portion of your cash value associated with the loan, reducing the overall earnings of your cash value while the loan is outstanding. If you do not repay the loan during your lifetime, the loan amount plus any unpaid interest will be deducted from the policy’s death benefit before it is paid to the beneficiaries.

Withdrawals: You also have the option to withdraw funds directly from the cash value without paying interest or repaying the amount. However, similar to loans, the withdrawn amount is deducted from the death benefit and reduces the cash value that remains to earn interest. Withdrawn amounts are typically tax-free up to the amount you’ve paid in premiums, but any excess may be taxable.

It’s important to note that both withdrawals and loans can affect the policy’s performance. If the cash value drops too low and cannot cover the policy’s expenses and mortality charges, the policy can lapse and terminate. Therefore, careful monitoring of your policy’s performance is crucial if you choose to make withdrawals or take out loans against an IUL.

A convenient feature of IUL policies is their flexibility in premium payments, allowing adjustments based on your financial situation:

Minimum Premiums: After the first year, you can choose how much to pay, including making only minimum payments, skipping payments, or making no payments at all, as long as the policy’s cash value covers the cost of maintaining it. If the cash value drops too low, the policy could lapse. Opting for minimum payments may necessitate increased premiums or a reduced death benefit as you age to keep the policy active.

Targeted Premium Strategy: This involves paying a set premium intended to keep the policy active through age 95 or 100, similar to whole life insurance. However, these target premiums are not guaranteed, and if the cash value falls short, you may need to increase your premium or reduce the death benefit.

Prefunding: Policyowners can make large payments early on to build cash value faster, potentially reducing required premiums later.

Indexed universal life insurance policies come with a combination of advantages and disadvantages that can impact your decision on whether they align with your financial objectives. Here’s a summary to help you assess these pros and cons.

ProsCons
Flexibility: Adjust premiums and death benefits as needed.Limited growth potential: The maximum interest you can earn is capped.
Tax advantages: Tax-deferred cash value growth and tax-free death benefit.Complex to understand: Requires knowledge of how interest rates, caps, participation rates and market indices work.
Guaranteed minimum interest rate: Protects cash value from market downturns.Can be expensive: Higher fees and premiums compared to other life insurance types.
Ability to withdraw from cash value: Access funds without accruing interest.Potential for policy lapse: If cash value drops too low, the policy may terminate.

The cost of indexed universal life (IUL) insurance varies based on several factors, including personal details and policy specifics. Understanding these elements can help you anticipate costs when considering this type of insurance. Here are key factors to keep in mind and how they might influence the cost of an IUL policy.

Personal Factors: Your age, health, lifestyle, and gender significantly impact the cost of IUL insurance. Younger and healthier applicants typically pay lower premiums, while risky behaviors like smoking can increase rates. Additionally, premiums can differ between males and females.

Policy Details: The coverage amount and any added riders also influence the cost. Higher death benefits result in higher premiums, so a $3 million death benefit will cost more than a $500,000 death benefit. Adding riders, such as a child rider or waiver of premium, usually increases the price as well.

Market Factors: The participation rate, cap rate, and floor rate of your policy play crucial roles in determining costs. The participation rate dictates how much of the index’s gain is credited to your cash value, with a higher rate leading to greater accumulation and potentially lower premiums over time. The cap rate limits the maximum interest credited to your cash value, while the floor rate guarantees a minimum interest, protecting your policy from market downturns but also affecting premium costs.

Premium Flexibility: IUL policies have minimum premium requirements to stay active. If the cash value gets too low, additional premiums might be needed to prevent lapse, potentially increasing costs. Some policyholders choose target premiums for consistent payments, aiming for longevity, while others opt to pre-fund to reduce future premiums.

The cost of an IUL can be a moving target. To better understand these nuances, consulting with a licensed agent or using an IUL calculator can help narrow down your specific costs.

Indexed universal life (IUL) policies might be a suitable option for individuals who are comfortable with a certain level of risk but are not willing to take on the full investment risk associated with variable universal life policies. IUL policies typically provide some guarantees, making them appealing to those seeking a balance between potential growth and security. This type of policy could be ideal for people who desire flexibility in their insurance, allowing for adjustments in premium payments and death benefits as their life circumstances change.

However, policyholders should be prepared to monitor their policy closely to ensure it does not lapse due to low cash values. Although IULs have a cash value component, it is important to remember that life insurance should not be viewed as a replacement for retirement plans such as 401(k)s or IRAs.

Indexed universal life insurance isn’t suitable for everyone. The insurance market provides a range of life insurance policies, and depending on your specific circumstances, one of the following types of life insurance might better suit your needs and budget.

Term life insurance provides coverage for a set period, usually 10 to 30 years. These policies offer a death benefit but do not accumulate cash value. Many term life policies are renewable, allowing policyholders to extend coverage for another term, albeit at a higher premium due to their older age. When the coverage period ends, most term life policies do not refund premiums and have an age limit, typically around 80. Term life insurance is typically the most affordable option, particularly for those who buy coverage when they are young and in good health.

Whole life insurance is a form of permanent life insurance known for its stable premiums and consistent death benefit. Similar to IUL policies, whole life insurance builds cash value over time, which can be borrowed against. These policies provide coverage for your entire life, though it’s crucial to understand that coverage typically ends at a designated age, typically between 95 and 121 years old, depending on the policy terms. This ensures lifelong protection as long as premiums are maintained.

Variable life insurance, a form of permanent life coverage, includes both a death benefit and a cash value component. Unlike IULs, variable life policies empower policyholders to select their preferred investments, such as mutual funds and exchange-traded funds. This flexibility in investment choice distinguishes variable life policies, yet it also entails greater risk. Poor investment performance can lead to decreases in the policy’s cash value and death benefit.

Universal life insurance operates similarly to IULs, but instead of building cash value based on a market index, it accumulates cash value based on an interest rate declared by the insurer. This form of permanent life insurance also permits policyholders to modify their death benefits and premiums.

Variable universal life insurance, a type of permanent life coverage, blends the characteristics of variable and universal life policies. This policy allows policyholders to invest their savings according to their preferences and also offers flexibility in adjusting premiums.

While indexed universal life insurance is distinctive in its design, it should not be considered a substitute for a retirement savings plan. Although it provides flexibility and potential growth through its cash value component, its primary function remains to provide a death benefit and financial security for your beneficiaries.