Policyowners of indexed universal life (IUL) enjoy virtually all the advantages they would enjoy if they owned regular universal life policies including (among others associated with all life insurance in general):
the flexibility to vary premiums and change face amounts;
the transparency and unbundling of the policy elements allowing them to easily track and compare insurance company projections of these elements and actual performance over time;
the availability of all three death benefit pattern options;
access to the whole panoply of riders and special policy provisions;
use of back-end loads (surrender charges) that phase out over time rather than the front-end loads typical of other types of policies;
the availability of policy loans from cash values at low or (in periods of high equity index returns) even negative net cost; and
a guaranteed minimum interest crediting rate.
Related: 10 advantages of term life insurance
Policyowners of index universal life bear virtually all the disadvantages they would bear if they owned regular universal life policies. Many of these disadvantages stem from or are natural consequences of the advantages IUL offers.
The unique advantage of IUL, however, is that it allows policyowners to earn potentially higher returns tied to the performance of equity indexes, similar to VUL policies, while retaining the safety afforded by the insurer’s guaranteed minimum interest crediting rate, similar to regular UL policies.
Keep reading to explore to unique advantages of IUL, as outlined in the 6th Edition of ”The Tools & Techniques of Life Insurance Planning” (2015, The National Underwriter Company).
IUL has been extremely popular in the family market, and for good reason. (Photo: iStock)
Advantage No. 1: The safety of no negative returns.
Clients burned in recent years by declining values in the equity, bond and real estate markets now understand the value of a guarantee that their annual returns will never be negative. That guarantee is precisely what IUL provides. If the index used by the product (or selected by the policyowner) declines over the period measured, the client is completely protected from that risk. The contract’s cash value will never decline due to declining values in the reference index.
IUL also has become extremely popular in the business market where flexibility is often essential. (Photo: iStock)
Advantage No. 2: The insurer absorbs the investment risk.
The insurance company provides interest credits to the IUL policy by investing in bonds and index options (or options on index futures). Suppose some experts expect bond defaults this year to be several times historical averages or that the counterparty to the index options defaults, like Lehman Brothers did to many insurers. How would such events affect the amounts credited to an IUL policy’s cash values? The answer is that the insurer bears the entire investment risk and protects its policyowners from this risk.
IUL can be well-suited to people who are looking for some of the upside potential of equities in their cash values while being protected on the downside. (Photo: iStock)
Advantage No. 3: The possibility of high positive returns.
Safe alternatives with low investment risk currently are earning very low yields. Many are at historical lows, making them unattractive to many savers. Even if and when interest yields on safe alternatives rise, the probabilities are that returns on higher-risk equities generally will be higher. With IUL, if the index performs well over the period measured, the amount the insurer will credit on the cash values tied to the index should be quite attractive. Some IUL policies even include interest-crediting formulas that compare multiple indices and more heavily weight those that are performing better.
IUL policyholders whose circumstances change can later reconfigure the policy by changing their premium payments and/or death benefit. (Photo: iStock)
Advantage No. 4: The ability to create tax-free cash flows.
Many other vehicles investors can use to save create taxation. IRAs and 401(k)s, for example, delay but do not eliminate taxation. IUL, in contrast, can create a totally tax-free cash flow. Through the use of policy loans, policyowners can completely avoid federal, state, and local income taxes, as well as the alternative minimum tax on the cash flow. And IUL, like all life insurance policies, provide a tax-free death benefit. This tax-free feature makes the IUL policies more attractive than other alternatives, even if those alternatives may create a somewhat higher pre-tax return.
IUL is beginning to surpass UL as the preferred vehicle in all sorts of business applications including split-dollar plans, funding for nonqualified deferred compensation plans, and more. (Photo: iStock)
Advantage No. 5: An ability to take advantage of the design of certain insurance products.
Studies show that the interest crediting on most IUL policies is higher than the interest crediting on most index annuity products. Why? Because insurers have a second source of profit on index universal life–the spread between the insurers’ mortality charges versus the expected mortality of the people they insure. In some cases, the insurers are generating much if not all of their profits from the mortality spread. Therefore, customers who buy IUL policies and minimize the insurance coverage relative to the premium they pay get a better deal. From one perspective, this means that the many policyowners who will maximize their insurance coverage relative to the premiums they pay essentially will be subsidizing these customers’ who maximize their coverage relative to the premiums they pay.
An IUL policy is indicated whenever the prospect desires the ultimate in life insurance flexibility. (Photo: iStock)
Advantage No. 6: Life-long insurance without paying for a lifetime.
One perhaps unexpected bonus for clients who use IUL to save for retirement is that once the clients stop paying premiums and start taking cash flows as policy loans, the insurance coverage does not end. In fact, clients often can continue to be insured for the rest of their lives without ever having to pay additional money into the contracts.
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