Indexed Universal Life – Pros and Cons
Indexed Universal Life Insurance or IUL is a hotly debated topic in the financial world. Most advisors have a strong bias for or against IUL. If you google IUL, you will find opinions leaning one way or the other. Unfortunately, for the consumer, many of these articles are misleading or just outright false.
In order to help educate on the good and bad, we discuss the pros and cons of indexed universal life insurance below. You might also want to read our beginner’s guide to indexed universal life if you’re unfamiliar with the mechanics.
At Abrams Insurance Solutions, we believe in helping our clients achieve their financial goals with the best strategy, no matter what that is. Often a combination of indexed universal life and stock market investments offers a great solution to maximize growth while minimizing risk and taxes. If you have any questions or want to do a deep dive into an IUL, reach out at (858) 703-6178.
Table of contents
What is Indexed Universal Life Insurance?
Indexed universal life insurance provides a death benefit like all life insurance. The use of an IUL as a savings vehicle provides a unique aspect to this type of insurance and wealth-building opportunities during your life.
You accumulate cash inside the policy. This cash earns good returns and does not include stock market risk. The cash can be used on a tax-favored basis with more flexibility than retirement accounts, such as a 401(k) or IRA.
Pros of Indexed Universal Life
IUL has massive advantages for the family with the disposable income to take advantage of it.
In a nutshell, you’re creating your own bank – with lower interest rates and no-questions-asked loans.
High Potential Returns
IUL has excellent potential returns out of all the universal life policy types. The rate of return ties to a stock market index, which means you get to participate in the growth of the market without the downside risk.
No Market Risk
The cash in your IUL is not directly invested in the stock market so you are not exposed to stock market losses. Depending on the index, you may be limited on some of the upside growth. However, this is more than offset by not being exposed to losses when the index has a negative year. The worst case is that you earn 0% for the year (minus policy expenses).
If you have money in the stock market that may have a down year, an IUL can be a great way to hedge that risk.
Because people build wealth in different ways, financial products need to have many customization options. IUL offers many different ways to design the policy.
The policy can have a death benefit focus or a tax-free distribution focus. The premium could be a lot or a little, depending on your cash flow.
With a 401(k) or IRA, you have to be 59.5 years old to access your money without a penalty and taxes. You can access your money in an IUL at any age without penalties and taxes.
Zero Capital Gains
You typically need to pay taxes on your gains in the stock market. Since you can remove money from an IUL through policy loans, you don’t have to pay taxes on the money distributed from your policy.
No Contribution Limit
The death benefit on your policy determines the contribution limit for funding your IUL. It’s typically based on a multiple of your income. Depending on your income, you can usually save much more money into an IUL than a 401(k) or IRA.
Locked in Gains & Annual Reset
The annual reset of an IUL creates the most massive opportunity for growth. Your gains are locked each year so they never lose value. But, when the index has a terrible year, your growth effectively resets from the point of the market’s loss.
Let’s say the S&P 500 drops from 3,300 to 2,500 one year. Your growth rate resets to start at the low, 2,500. The insurer will credit any growth from that reset point to your cash value. Not only does the drop not affect you, but you also start growing from a lower point.
You can borrow against the cash value at any time for any reason in your policy. Once you have your emergency fund in the bank, an IUL can be a great savings option with much more growth.
To combat the rising costs of end-of-life care, whether that comes in the form of assistance in the home or moving to assisted living, many insurers are adding living benefits to their insurance policies.
These allow you to take some of your death benefits early in cases of terminal illness, critical illness, or needing assistance with activities of daily living.
People will often use a life insurance policy with a chronic care or long-term care rider instead of a standalone long-term care policy.
Doesn’t Impact Social Security Benefits
Your income impacts your medicare premiums and taxes on your social security. For social security purposes, money from your life insurance policy does not get reported to the IRS and is not considered taxable income. This makes the massive growth of an IUL even more lucrative for minimizing your tax burden during retirement.
Cons of Indexed Universal Life
While most of the information you read about IUL on the internet slamming it is fear-based or from people who don’t understand the product, there are some drawbacks to consider.
Returns May Be Capped
While floors are fantastic for not losing money, the trade-off happens on the return ceiling. Your returns may be limited by caps or participation rates. Let’s say an index has a cap of 12% and that index returns 14%. You will receive a 12% interest credit.
Skeptics will tout this as a cash grab from the insurance company, but it’s a small price to pay for the floor. Plus, when you run the math, steady (if measured) growth always outperforms radical swings in loss and growth.
Some insurance companies also offer uncapped indices.
Must Qualify Health-Wise for Life Insurance
You still need to qualify for life insurance. The larger the policy, the more underwriting. Maximizing the wealth-building potential means this strategy is best for people in decent health who don’t smoke. Poor health or smoking increases the rates for the insurance component and may not yield the ideal results.
Agent Must Know How to Design the Policy to Best Help Their Client
After doing your research on an IUL, only work with an agent who has experience in designing them. Most agents shy away from the product because it’s complicated, and term or whole life is a better fit for many people.
To work well, an IUL requires customization to fit the insured. If designed poorly, it can quickly take on the worst-case scenario route that talking heads like to paint about IULs.
Each client has different needs and goals for the agent to consider, meaning the IUL they designed for another client likely won’t fit you.
We at Abrams Insurance Solutions are experts at properly designing IULs to best help our clients. We practice what we preach and own an IUL. We’re happy to share the results of our policy with you.
Who Should Consider IUL?
Before looking into IULs, you should be financially stable, have an emergency fund saved, and need life insurance.
If you max out your 401(k), you might think about only saving enough to get the match. Then look at funding an IUL with anything above the match.
For example, someone in their 20s could benefit from saving just $250 a month into a policy. That assumes that they are already saving for retirement by maxing out their IRA or 401(k) match. Our rule of thumb here at Abrams Insurance Solutions is max out the company 401(k) match then take advantage of the flexibility of an IUL with anything above that. But an IUL isn’t the only option.
There are a few primary purposes for an IUL:
- Life insurance to protect your family or business
- Creating a tax-free income stream in retirement
- You earn too much to contribute to a Roth IRA
- College funding through life insurance
- Interest in becoming your own bank to fund anything – business ventures, real estate investments, etc.
- Long term care alternative
- Life insurance for estate planning to offset taxes
It’s Not For Me, But I Like The Concept – Now What?
If an indexed universal life policy isn’t in your immediate future, there are many other life insurance options. If cost is most important, then term life insurance may be a better fit.
Questions? Contact us and we will point you in the right direction.
Want to learn more about indexed universal life?
If this tax-free wealth-building strategy sounds like a good idea, we have a great video course on learning how to build tax-free wealth. You can sign up for the course at no charge here.
If you earn $100,000 or more, we have access to a strategy that combines leverage (other people’s money) with an IUL. This is a great way to increase your retirement income by 60 to 100%. You can learn more about this wealth-building strategy here.
If your priority is protecting your savings from taxes and stock market risk, an IUL may be a great asset for you to own. If you max out your 401(k) or earn too much to contribute to a Roth, an IUL will fit the bill.
If you are looking for the cheapest insurance, then a term policy is a better option. Maybe you can add an IUL in the future if it makes sense.
If you want to get an honest opinion on what is best for you, please reach out to us.
How Abrams Insurance Services Can Help
We are a group of independent agents licensed to help families all over the United States secure their financial foundation and move into building wealth. We believe that since insurance comes in many forms, the product should be fit to the family and not the family to the product.
If you have any questions about building wealth, protecting your family, or planning for retirement, give us a call at (858) 703-6178. Whether it be a term policy, IUL, or investments, we’ll help guide you to the best solution for your family.