Pros & Cons of Indexed Universal Life Insurance

by Rod Howell

If you’re looking for a permanent life insurance plan to provide financial security for your loved ones if you die, you can purchase an indexed universal life insurance policy. This type of coverage comes with a death benefit that can be increased by funds accumulating within the policy. This policy provides several other features you can benefit from as a policyholder while you're living.

Cash Value Account

An indexed universal life insurance policy comes with a cash value account. The net premiums, which are what’s left of your insurance payments after fees are deducted, are deposited into a tax-deferred account. The insurer applies an interest rate with a guaranteed minimum to the cash value account, and this builds the account faster. You can have access to this money at any time via policy loans you don’t have to pay back. When you take out a policy loan, you get the money on a tax-free basis. However, if you don’t pay back the loan and you die, the amount paid to your beneficiaries will be reduced by the outstanding amount. If your policy loan isn’t paid and your policy lapses or gets canceled, the balance owed may be considered a capital gain and is subject to income taxes.

Capitalize on Market Success, Safe on Market Downturn

With an indexed universal life insurance policy, you can designate a specific value of your cash value to be invested in a market index of your choice, such as Standard and Poor’s 500. When the market index does well, you benefit as the insurer credits your policy with interest. The better the index performs, the higher the interest. You are also protected when the market index you chose does poorly. When a loss happens, a zero percent interest rate is applied to your cash value account, guaranteeing that your policy won’t lose any money.

Flexibility

Flexibility is another benefit of an indexed universal life insurance policy. You don’t have to pay your premium payments out of pocket if you don’t have the money. You can pay your premiums with the money in your cash value account if you have enough funds to cover the payments. You can change your premium payment amounts and the frequency at which you pay them. You can also increase or decrease the account's face value amount according to your needs.

Drawbacks

An indexed universal life insurance policy has some drawbacks. When the market index is doing great, this policy caps how much interest is credited to your policy. And the account's flexibility can cause problems if you aren't disciplined about making premium payments: By skipping too many premium payments and covering the costs with the money in the cash value account, you can put your policy in jeopardy. If you don’t have enough funds to cover premium payments, your policy could lapse. Poor index performances can lead to higher premium costs. And the indexed universal life insurance policy has fewer guarantees than other permanent life insurance policies, such as whole life, and fewer investment options compared to variable universal life insurance.

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