Indexed universal life insurance (IUL) is a type of permanent life insurance that combines a death benefit with a cash value account. It’s designed to provide lifelong coverage and build cash value over time, with the potential to earn higher returns than traditional whole life insurance.

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What is Indexed Universal Life Insurance?

IUL is a type of life insurance that ties the growth of your cash value to the performance of a stock market index, such as the S&P 500. This means that your cash value can potentially earn higher returns than traditional whole life insurance, but it also comes with more complexity and risk.

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Every premium payment you make for a IUL policy is generally split three ways:

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• Part of your premium: Goes towards the cost of insurance and policy fees and expenses.
• Funds your life insurance coverage and death benefit.
• Cash value: Accumulates over time and earns interest based on your policy’s crediting method.

As with all cash value life insurance, you may be able to borrow against your balance, withdraw funds, or even use it to help cover future premiums. However, loans and withdrawals can reduce your death benefit and, if not managed carefully, may lead to your policy lapsing.

How Indexed Universal Life Insurance Builds Cash Value

The biggest difference between an IUL policy and other permanent life insurance policies is how the cash value earns interest. With whole life insurance, you earn a fixed interest rate on the cash value portion of your balance. With an IUL policy, the interest you receive is tied to the performance of a stock market index.

That said, your money isn’t actually invested in the stock market. Instead, the insurance company uses the index as a benchmark to determine how much interest to credit to the cash value portion of your policy. If the index performs well, your cash value may earn more interest. If the index has a bad year, your credited interest may be lower (sometimes even 0%), depending on your policy’s terms.

Caps, Floors, and Participation Rates: What You Need to Know

When you hear that an IUL’s cash value is linked to the stock market, you may assume you’ll earn whatever the market earns. But that’s rarely how it works.

Most IUL policies include features like caps, floors, and participation rates that can limit how much interest gets credited to your policy.

What is a cap rate? A cap is the maximum interest your policy can earn during a crediting period. You can usually find your cap in your policy illustration or documents.

What is a floor? A floor is the minimum interest rate your policy can receive. Many IUL policies have a 0% floor, meaning you won’t lose cash value simply because the underlying market index has a negative year.

What is a participation rate? A participation rate determines how much of the index’s gain is credited to your policy.

How the Death Benefit Works in an IUL Policy

Most indexed universal life policies let you choose between two types of death benefits:

• Option A: Level death benefit – Your beneficiaries receive a fixed death benefit throughout the life of the policy.
• Option B: Increasing death benefit – Your beneficiaries receive the policy’s face amount plus the accumulated cash value (or, depending on the policy, a death benefit that increases as the cash value grows).

How Premium Flexibility Works in an IUL

One big draw of universal life insurance policies in general is that you can make adjustments to your premiums (within certain limits). For instance, you may be able to increase, decrease, or even temporarily skip premium payments if your policy has built up enough cash value to cover its ongoing costs.

Indexed Universal Life vs. Other Types of Life Insurance

Indexed universal life insurance can be compared to other types of life insurance, such as whole life and term life insurance. While IUL provides lifelong coverage and the potential to earn higher returns, it also comes with more complexity and risk.