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In exchange for paying premiums, life insuranceprovides beneficiaries with a large payment upon the insured’s death. It’s a way to protect your family after you pass, especially if that happens when they still depend on you financially. But there are many varieties of life insurance, including indexed universal life (IUL) insurance. This allows the cash value of your policy to grow when certain stock market indexes are doing well while protecting you from losses. A financial advisor can help you choose an insurance policy that fits into your financial plan.
Explaining Indexed Universal Life (IUL) Insurance
Indexed universal life insurance, or IUL, is a type of universal life insurance. Rather than the cash value portion growing on a fixed interest rate, it’s tied to the performance of a market index, like the S&P 500.
Unlike investing directly in an index fund, however, you won’t lose money when the market has a downturn. This is because a guarantee applies to your principal, insuring it against losses. On the other hand, there’s usually a cap on the maximum return you can earn. Many times, you’ll also be able to divideyour assets between fixed and indexed portions of your policy.
To better understand IUL, it helps to have a grip on the maintypes of life insurance. Broadly speaking, the two main versions are term life insurance and permanent insurance. Within the latter category, there are many varieties, the most common of which are whole life and universal lifeinsurance.
The table below displays how one IUL policy works given four different changes in the selected market index. Various IUL policies have a variety of index caps and index floors.
How Indexed Universal Life Insurance Works | |||
Change in index | Index cap | Index floor | Change in cash value |
9% | 8% | 0% | 8% |
2.5% | 8% | 0% | 2.5% |
-11% | 8% | 0% | 0% |
-3 | 8% | 0% | 0% |
What Are the Benefits of IUL Insurance?
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One of the most attractive features of an IUL is the ability to take advantage of stock market returns without the risk of loss. And it does so while building up a death benefit that your beneficiaries will receive tax-free.
Other benefits of indexed universal life insurance include:
Downsides of IUL Insurance
There are many reasons to buy an IUL insurance policy.Like any financial product or policy, though, there are some drawbacks that might hold you back from investing in an IUL. Critics point to high fees associated with permanent life policies, including sales and administrative fees.
By contrast, a retirement account, especially one comprised of low-cost ETFs or mutual funds, will lose significantly less to fees. Someone seeking both life insurance protection and tax-free retirement distributions might be better off getting a term life policy (which tends to be much cheaper) and opening a Roth IRA, rather than trying to combine the benefits into one product.
Other cons of IUL insurance include:
Should You Get Indexed Universal Life Insurance?
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While an IUL policy has some generous upsides, it might not work for everyone. Experts say that if you are an investor in your 20s, buying index funds or saving for retirement in a 401(k) or IRA might be a better fit.
“If someone has no need for life insurance, then another vehicle may be more appropriate for them,” Abrams says. That might mean just saving in a 401(k) or IRA. Of course, those accounts are subject to contribution limits and don’t offer the same principal guarantees. But less of your investment will go towards fees, and you won’t have a cap on returns when the market has a great year.
Abrams adds, too, that IULs aren’t for short-term investors.
“An IUL is a long-term vehicle,” he says. “When saving money in an IUL, you shouldn’t plan on taking any income from [it] for at least 10 years or longer.”
Bottom Line
Life insurancebeneficiaries get a large payment on the insured’s death. But some varieties of life insurance like indexed universal life (IUL) insurance will allow the cash value of your policy to grow when certain stock market indexes are doing well and protect you from losses. IULs, however, are not a good fit for everyone. And if you are a young investor, you should consider other options likebuying index funds or saving for retirement in a 401(k) or IRA.
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