indexed universal life

Indexed universal life (IUL) insurance is a type of universal life insurance that provides a cash value component along with a death benefit. The money in a policyholder's cash value account can earn interest by tracking a stock market index selected by the insurer, such as the Nasdaq-100 or the Standard & Poor's 500. If your policy also has a fixed-rate account, you can choose how much you want to go into each account.

Although the interest rate derived from the equity index account can fluctuate, the policy does offer an interest rate guarantee, which limits your losses.1 It also may cap your gains. These policies are more volatile than fixed universal life policies, but less risky than variable UL insurance policies because IUL does not invest in equity positions.

• Indexed universal life (IUL) insurance lets the policyholder decide how much cash value to assign to an equity-indexed account and to a fixed-rate account, if available.

• Indexed universal life is a form of permanent life insurance that (like universal life) allows for flexible premiums and possibly a flexible death benefit.

• IUL insurance policies can track a number of well-known equity indexes, such as the S&P 500 or the Nasdaq-100, to earn interest credits.

• IUL policies usually cap your returns but also guarantee a minimum interest rate.

As with universal life insurance, IUL policies have adjustable premiums. You can underpay or skip premiums, plus you may be able to adjust your death benefit. What makes IUL different is the way the cash value is invested.

When you take out an indexed universal life insurance policy, the insurance company provides several options to select at least one index to use for all or part of the cash value account segment of your policy and your death benefit. When a premium is paid on the account, a portion pays the cost of insurance based on the insured's life; any fees are paid; and the rest is added to the cash value.

The total cash value is credited with interest based on increases in an equity index (although your money isn't directly invested in the stock market). If you own an indexed universal life policy, you can likely borrow against the cash value accumulated in the policy. However, if you don't pay back your loans, they are deducted from the death benefit.

IUL insurance offers these main features, among others:

• Permanent, lifelong coverage when premiums are kept up to date.

• Flexible premiums, and a death benefit that may also be flexible.

• Cash value, along with potential growth of that value through an equity index account.

• An option to allocate part of the cash value to a fixed interest option.

• Minimum interest rate guarantees ("floors"), but there may also be a cap on gains, typically around 8%-12%.

• Accumulated cash value can be used to lower or potentially cover premiums without subtracting from your death benefit.

Some policies may allow the policyholder to select multiple indexes.

Policyholders can decide the percentage allocated to the fixed and indexed accounts. The value of the selected index is recorded at the beginning of the month and compared with the value at the end of the month. If the index increases during the month, interest is added to the cash value. The index gains are credited back to the policy, either on a monthly or an annual basis.

Let's say your selected index for your IUL policy gained 8% from the beginning of June to the end of June. The 8% is multiplied by the cash value. The resulting interest is added to the cash value. Some policies calculate the index gains as the sum of the changes for the period, while other policies take an average of the daily gains for a month. No interest is credited to the cash account if the index goes down instead of up.

The gains from the index are credited to the policy based on a percentage rate, referred to as the participation rate. The rate is set by the insurance company and can be anywhere from 25% to more than 100%. (The insurer can also change the participate rate over the lifetime of the policy.) For example, if the gain is 8%, the participation rate is 100%, and the current cash value total is $10,000, $800 is added to the cash value (8% x 1000% x $10,000 = $800).

**IUL insurance policies are less risky than variable life insurance because no cash is directly invested in the stock market.**

While not for everyone, IUL insurance policies are a viable option for people seeking permanent life insurance with a cash component that earns interest plus a death benefit. This type of life insurance is more expensive than term life insurance, but you get permanent coverage and the death benefit paid tax-free to your beneficiaries when you die. The policy may increase in value due to the cash value component and you may be able to borrow from your account. There are a number of pros and cons to consider before purchasing an IUL policy.

• Flexible premiums: As with standard universal life insurance, the policyholder can increase their premiums or lower them in times of hardship.

• Cash value accumulation: Amounts credited to the cash value grow tax-deferred. The cash value can pay the insurance premiums, allowing the policyholder to reduce or stop making out-of-pocket premium payments.

• Investment flexibility: The policyholder controls the amount risked in equity-indexed accounts and the death benefit amounts can be adjusted as needed. Most IUL insurance policies offer a host of optional riders, from death benefit guarantees to no-lapse guarantees.

• Death benefit: This benefit is permanent, not subject to income or death taxes, and not required to go through probate. Internal Revenue Service. "Do I Report Proceeds Paid Under a Life Insurance Contract as Taxable Income?"

• Less risk: The policy is not directly invested in the stock market, reducing risk.

• Easier distribution: The cash value in IUL insurance policies can be accessed at any time without penalty, regardless of a person’s age.

• Unlimited contribution: IUL insurance policies have no limitations on annual contributions.

• Extended maturity date: Many IUL policies have a later maturity date than other types of universal life policies, with some ending when the insured reaches age 121 or more. If the insured is still alive at that time, policies pay out the death benefit (but not usually the cash value) and the proceeds may be taxable.

• Based on a variable equity index: If the index goes down, no interest is credited to the cash value. (Some policies offer a low guaranteed rate over a longer period.) Other investment vehicles use market indexes as a benchmark for performance. Their goal normally is to outperform the index. With IUL, the goal is to profit from upward movements in the index.
  
• Growth does not include stock dividends: Because the insurance company only buys options in an index, you're not directly invested in stocks, so you don't benefit when companies pay dividends to shareholders.

• Management fees: Insurers charge fees for managing your money, which can drain cash value.

• Premium calls: Once your policy value grows enough to cover your premiums and other expenses, you can decide to skip or underpay premiums. If so, you should monitor your cash value regularly to make sure the cash value remains to cover those costs. Otherwise, the insurance company can require you to add more funds to prevent the policy from lapsing.

• Tax consequences of loans and withdrawals: If you withdraw money that includes investment gains before your policy matures, you could face income taxes on that funds. Also, if your policy lapses with an outstanding loan, the loan could become taxable.