Is IUL a Good Investment?

Tired of stock market rollercoaster returns? Want the peace of mind that your investments are protected, even when the markets drop? Indexed Universal Life (IUL) insurance might be the solution. IUL can be a good investment if it helps you achieve your financial goals. But is it too good to be true? Let's look at how IULs work and how they can be useful as part of your investment portfolio.

What is an IUL?

An IUL (indexed universal life insurance) is a type of universal insurance featuring index-linked investing. It’s a life insurance policy that provides permanent coverage and a cash value component. Unlike more traditional life insurance policies, whole-life or term life insurance policies, an IUL has an investment component.

How Does Indexed Universal Life Insurance (IUL) Work as an Investment?

Indexed universal life (IUL) insurance gives you life insurance coverage and a way to grow your cash investment.

In IUL insurance, you get different investment accounts that can be used to grow your cash value:

• A fixed account with a guaranteed interest rate. This cash value portion is the safest option since your investment growth is constant and predictable. Each year, the insurer will declare a fixed interest rate that will be applied to any money you have invested in this portion of your IUL policy.
• Equity-indexed accounts can grow your cash value linked to stock market returns. The insurer will usually offer a diverse range of indicies, including the S&P 500, the Hang Seng and the Eurostoxx. The performance of each index determines your interest rate.

You can allocate funds across these different cash accounts to fit your investment needs and risk profile. The more equity market-linked exposure you have the more growth potential for your IUL.

Protection from Market Downturns

Arguably, the best investment feature of IULs is the protection they give you from falling stock markets. Indexed universal life insurance policies have a floor, a minimum guaranteed rate that protects your investment from market downturns. Many of the best IUL insurance policies have a 0% or 1% floor rate, so even if the market performs poorly, you are guaranteed never to lose money invested in your index-linked account from market drops.

Dollar Cost Average Market Returns

Indexed universal life (IUL) premiums are flexible, meaning you can raise or lower your premium payments. So, if you are invested in the equity-linked strategies of an IUL you can buy the market you are tracking on the dips.

You can also take advantage of dollar cost averaging your returns by allowing the insurance company to do it for you. Hand them a premium and they will put this to work each month dripping some of your premium into the market which you are tracking. It takes away all the paperwork and time to do this yourself.

And on top of this, the insurer will allocate your premium to the fixed account so you will be earning money on the portion of your premium not invested into the equity market strategy you have chosen.

For nervous investors, or those wanting to smooth out their stock market entry point, this IUL dollar cost average strategy could work well.

At the end of each year, the return of your different accounts is calculated and annual interest is credited to your IUL value.

As well as investment choices, investing in IUL also offers other benefits.

Tax-Deferred Growth

The cash account in an indexed universal life (IUL) insurance policy grows tax-free. That means it won’t be subject to taxes while your money is still in the policy.

Liquidity through Loans and Withdrawals

You can easily access money stored in your IUL cash accounts through policy loans and withdrawals. It means you can access your accumulated investment for emergency expenses, or investment opportunities, with a policy loan from your policy without needing a bank loan.

Withdrawals from your IUL can be part of your overall financial planning strategy to fund retirement planning.

It is important to speak with your financial advisor before taking an IUL policy loan or withdrawal to check the tax position and also the effect on the policy itself.

Tax-Free Death Benefit

Death benefit payouts from life insurance are tax-free, meaning the entire cash sum is received by the offshore structure* owning and holding the permanent insurance policy free of tax when the policyholder dies. However, it is important to check the tax rules of the country where your ultimate beneficiaries live. Some countries will have tax on the lump sum payout when the ultimate beneficiary receives it.

*In most cases, an international IUL policy must be owned by an offshore structure, typically a trust or company

No Annual Contribution Limits

Retirement accounts usually have contribution limits. IUL and other life insurance policies don’t have any contribution limit, which means you can put in as much money as you want, as long as you have an insurable interest. If you are a high net worth individual or a high earner, saving into an IUL on top of other retirement accounts can be very attractive.

Adjustable Death Benefit

As time passes, you may find your insurance needs changing. An IUL facilitates this by letting you adjust your death benefit amount according to your needs. Whether you want to reduce or raise your death benefit, you have the flexibility to do so to ensure your family’s future.

Why is IUL a Good Investment?

Indexed universal life (IUL) insurance offers a unique blend of life insurance protection and investment growth potential. Its key benefits include tax-advantaged growth, flexibility in premium payments, potential for market-linked returns, and protection against market downturns.  IULs can be a smart choice for those seeking a long-term financial strategy that combines life insurance premiums for coverage and investment growth as part of an overall portfolio.

Why is IUL Considered a Bad Investment?

While IULs offer several tax benefits, for some investors, here's why they might be considered a bad investment in certain situations:

IULs often have caps on how much your investment can grow. IULs can be complex, with various fees that can eat into your returns over time and early exit penalties if you want to withdraw money in the early years of your policy.

Let's take a look at these areas of concern more closely.

Limited Market Upside Benefits

IULs have caps that limit your stock market returns. For instance, if the index you are tracking rises by 15% and your IUL has a 10% cap, your interest is limited to 10%.

This cap on IUL returns make them less attractive that holding full market exposure that a traditional investment portfolio would give you.

However, in exchange for this limited upside, an IUL floor prevents you from losing any cash value when your index’s market performance drops. This is unlike a traditional portfolio in which you would be facing all the market losses.

As well as caps, an IUL's participation rate governs how much money you can earn. Caps limit your returns, while participation rates control how much money will be added to your cash account.

Different life insurance companies may have varying caps and participation rates.

Complexity and Lack of Transparency

IULs can be hard to understand because they feature two investing components and have many moving parts. If you don’t fully understand your IUL policy, you may not be able to get the most out of it. 

Caps and Maximum Participation Rates

Caps and participation rates govern how much money you can earn. Caps limit your returns, while participation rates control how much money will be added to your cash account. If your IUL policy has a low cap and participation rate, you’ll receive less money from investment returns.

Potential for Dividends

While they aren’t guaranteed, you can often earn dividends with a traditional investment portfolio. Dividends can provide extra income on top of your investment returns, letting you grow your money faster. Compare that to an international IUL that will not pay dividends meaning you lose out on that part of equity growth.

Costs and Fees

All life insurance products have varying costs depending on the various insurance provider or company. However, IULs have numerous associated costs like premium loads, surrender charges, administrative expenses, and mortality charges. All these costs can add up and result in a higher cost to run an IUL policy.

Surrender Charges and Penalties

IULs impose surrender charges in the early years of owning a policy. If you cancel your IUL policy early, you’ll pay a surrender charge to get your money out. Therefore, you need to be sure that money you invest into an IUL is being invested for the long term.

Is Indexed Universal Life Right for You?

IULs might not be the right choice for everyone. If you're seeking maximum growth potential, want simplicity or need access to your funds, other investment options will be a better fit.

However, indexed universal life can be right for you if it supports your insurance needs as well as your financial goals. Here are some reasons why you should consider getting an IUL policy:

• Estate planning - you want the whole life insurance that an IUL gives you
• Diversification - adding life insurance as an asset class to your existing investment portfolio
• Retirement income - an IUL can provide an income for retirees which makes it an attractive addition to a retirement plan
• Cash access - use an IUL's cash value for cash loans or withdrawals as part of an overall portfolio
• Tax-free growth - IULs grow free of tax and pay out free of tax
• Stock market protected investing - IULs are an excellent way to hedge stock market returns

Indexed universal life insurance policies aren’t right for everybody, but if you fall into any or all of the criteria above, you may benefit from an IUL.

Indexed universal life insurance policies aren’t right for everybody, but they hold significant appeal for individuals with specific financial goals and priorities.  If you relate to any of the earlier scenarios, an IUL could be a powerful addition to your current financial protection strategy.

Frequently Asked Questions (FAQs)

How does money grow in an IUL?

Money grows in an IUL policy in two different ways:

• In the fixed cash value account, your money grows through a fixed interest rate. The interest rate is declared each year by the insurer making year to year returns predictable.
• In the index cash value account, your money grows alongside a market index’s performance. Your account grows faster if the market performs well. Annual returns are typically capped at 10 to 12% each year.

Can you lose money in an IUL?

You typically cannot lose money in an Indexed Universal Life (IUL) policy due to a 0% floor, which prevents cash value losses from market downturns. However, fees and policy costs can reduce cash value over time, especially if credited interest is low or nonexistent in certain years.

Can I sell my IUL?

Yes, you can sell your Indexed Universal Life (IUL) policy through a life settlement, where a third-party buyer pays you a lump sum in exchange for taking over the policy and its benefits. The sale amount depends on factors like policy value, age, and health status.

How long does an IUL last?

An Indexed Universal Life (IUL) policy can last a lifetime, provided premiums are paid and the policy maintains sufficient cash value to cover expenses. Unlike term policies, IULs are designed for lifelong coverage, with flexibility in premium payments affecting the policy’s duration and cash value.

How much do IULs return?

Indexed Universal Life (IUL) policies typically return an average of 6-7% annually, depending on the policy's cap rate, participation rate, and the performance of the linked index. While IULs benefit from market gains, they are also protected from losses, making returns generally moderate but stable over time.

Disclaimer

This article is authored by Carlton Crabbe, Chief Executive Officer of Capital for Life, a specialist indexed universal life insurance broker. The information provided in this article is for educational and informational purposes only and should not be construed as financial or investment advice. While the author possesses expertise in the subject matter, readers are advised to consult with a qualified financial advisor before making any investment decisions or purchasing any life insurance products.