Investing in a stock market index fund has been proven to be one of the smartest and most efficient ways to build long-term growth. What if we told you there was a way to invest in an index fund tax-free and potentially protect yourself from market volatility, all while having the peace of mind life insurance provides?
Well, you can. Put all those pieces together and you have something called “indexed universal life insurance.” In this post, we’ll explain what indexed universal life is, how it works, and who would benefit from an indexed universal life policy.
Indexed Universal Life, Explained
Indexed universal life insurance is a type of permanent life insurance where the policy’s cash value is invested in an index fund. Policyholders enjoy life insurance coverage for the rest of their lives, while also building long-term wealth in a tax-sheltered savings account.
Like other universal life insurance plans, the policy’s terms are flexible and can be changed (within limits) over time. However, one major advantage indexed universal life has over variable universal life insurance is its simplicity. While variable universal life policyholders decide from a selection of mutual funds (like a 401k retirement plan) how they’d like to invest their cash value, indexed universal life policies take out the guesswork and offer just one or two stock market indices (such as S&P 500 or the Nasdaq Composite) in which to invest.
How does indexed universal life insurance work?
An indexed universal life policy has two working parts. The first is a lifelong death benefit that will come in the form of an annual renewable term life insurance policy. A large portion of the premiums goes toward this policy plus any applicable fees.
The second part of an indexed universal life policy is the policy’s cash value. A portion of every premium payment goes toward the cash value component that is invested into a reliable stock market index. This portion of the policy is tax sheltered and credited on a monthly or annual basis.
Some insurers offer fixed index universal life policies, which guarantee a minimum investment return. This provides a significant advantage for risk-averse investors because if the market is down, the cash value will still post a gain. However, this stipulation also comes with an upper limit, meaning that if the index performs better than the cap, the insurer keeps the difference.
Indexed Universal Life Insurance Pros and Cons
There are several great advantages to an indexed universal life policy relative to other types of permanent life and term life policies. However, there are also a few drawbacks. Here’s what applicants need to know about the pros and cons of indexed universal life.
Indexed Universal Life Pros
Guaranteed Death Benefit
Coverage from indexed universal life insurance is permanent and will last the policy holder’s natural life. Policyholders only need to apply and qualify once, which means there’s no need to worry about changes in health status later on in life.
Greater Upside Potential
Unlike whole life or standard universal life where the policy’s cash value earns a fixed rate of interest, an indexed policy has the potential to grow more rapidly. For instance, financial data from April 2022 shows that the S&P 500 stock market index produced a 73 percent growth over the past five years. This means that indexed universal life policyholders most likely earned a greater cash value during that period than those with other types of permanent life policies.
Investment Return Floor
Perhaps one of the most interesting components of indexed universal life is that it offers a minimum guaranteed return. This eliminates a lot of the risk and worries for investors who are concerned about their portfolios suffering significant losses.
Tax-free Access to Cash
As the cash value of an indexed universal life policy builds, policyholders have the opportunity to borrow against it. And since the cash value grows in a tax shelter, these are effectively tax-free loans.
Flexible Premiums and Death Benefits
Indexed universal life policyholders can adjust their premiums and death benefits as needed. They can even use the policy’s cash value to pay for premiums, making the policy self-sustainable over time.
Indexed Universal Life Cons
Indexed Universal Life is More Expensive than Term Life Insurance
As with all permanent life insurance, budget-conscious applicants may be turned off by the price of indexed universal life policies. Relative to term life, indexed universal life costs more due to the cash value component, the guaranteed death benefit, and the fact that the policy doesn’t expire.
Investment Return Cap
If an indexed universal life policy offers a minimum guaranteed return, then it will also likely come with a fixed upper limit for gains. Any index fund gains over this cap go to the insurance company. This means that compared to freely investing in the same index fund, policy owners won’t see as great of returns over time.
Who should buy indexed universal life insurance?
Indexed universal life insurance is a great option for many people, including:
- Young families who want permanent coverage with a guaranteed growth potential
- Policyholders who are nervous about stock market volatility and looking for minimum investment return guarantees
- Older adults who’d like to make a large upfront investment into a tax-sheltered account outside their retirement accounts
If you’d like to know more about the benefits of indexed universal life insurance, please contact Principled Life to talk with one of our independent insurance brokers. Our experienced insurance advisors want to help you find the peace of mind the right life insurance policy can provide.
