Pros and Cons of Indexed Universal Life Insurance

by Cynthia Myers

When you shop for life insurance, you have many options, including term life, whole life, universal life, and indexed universal life, also known as equity indexed universal life. First introduced in 1997, indexed universal life combines a savings vehicle with a traditional policy that pays a benefit upon your death. An indexed universal life insurance policy accumulates a cash value that you can access during your lifetime and pays a death benefit. The cash value portion of the policy pays interest based on the rate of a market index, such as the Standard & Poor 500.

Investment Vehicle

An indexed universal life insurance policy allows you to buy a life insurance policy that also has an investment value. Whether or not this is the best use of your investment funds depends on your individual situation. For example, a 40-year old non-smoking male who purchases regular term life insurance instead of a higher-priced indexed universal life would have a higher return on his investment if he invests what he saves in premiums into an S&P 500 index fund. This is due in part to a cap on the maximum the universal life policy would pay in a year. According to a Lamar University study, the rate of return over time on an indexed universal life policy was higher than some other investment vehicles, such as Treasury bonds.

Market Fluctuations

Indexed universal life insurance policies are tied to the S&P 500, but policy caps may prevent it from keeping pace with the stock market during times of booming stock prices.

When markets are rising and the value of the index increases, the cash portion of the life insurance policy grows. For example, if the S&P 500 grows at a rate of 6 percent in a year, the cash value portion of your policy earns 6 percent interest. When the market falls, the policy still earns a guaranteed minimum interest rate and the death benefit remains intact. But most indexed universal life policies also have a cap on the maximum amount of interest they will pay in any one period. This means that in times of volatile growth in the stock market, your policy will grow at a slower rate than a comparable investment in the stock market would have grown.

Flexibility

Flexibility is a key advantage of any universal life policy, compared to whole life or term insurance. If you decide to stop making premium payments or to reduce the payments you make on your universal life policy, the cash value will be used to cover the premium costs so your life insurance will not lapse. Other types of policies require monthly premium payments to keep the policy in force regardless of the size of the cash value. Unlike term or whole life, universal policies also let you adjust the size of the death benefit while the policy is in effect.

Other Considerations

Indexed universal life insurance policies have higher premiums than term life insurance. If your primary interest is in purchasing a death benefit to leave to your heirs, term life is the most economical choice. As with many other investments, indexed universal life insurance policies have fees to manage the investment account, so that will reduce your overall rate of growth. Depending on the type of policy, you will owe taxes on gains and dividends earned by the policies, and may also owe capital gains taxes on any gains.

Photo Credits

  • Hemera Technologies/AbleStock.com/Getty Images