A Guide to Indexed and Variable Universal Life Insurance: Growing Your Cash Value with Market Performance

Universal life insurance offers policyholders the opportunity to customize their coverage while accumulating cash value. Two popular variations of universal life insurance are indexed universal life (IUL) and variable universal life (VUL).

Unlike traditional whole life insurance, these policies allow policyholders to potentially grow their cash value by linking it to market performance. This article serves as a guide to indexed and variable universal life insurance, explaining how these policies work, their benefits, considerations, and potential risks.

Indexed Universal Life Insurance (IUL)

Indexed universal life insurance (IUL) presents a unique form of permanent life insurance that amalgamates the security of traditional life insurance with the potential for cash value growth linked to the performance of a chosen market index, like the S&P 500. Let’s delve into the workings of IUL:

1. Cash Value Growth: The cash value in an IUL policy grows based on the performance of the chosen index. When the index performs well, the cash value increases. If the index experiences negative returns, the cash value remains unchanged but does not decrease.
2. Participation Rate and Cap: The insurance company sets a participation rate and cap that determine how much of the index’s gains are credited to the cash value. The participation rate represents the percentage of the index’s growth that is applied to the policy, while the cap limits the maximum credited interest rate.
3. Downside Protection: IUL policies typically include downside protection, ensuring that the cash value is not negatively affected by market downturns. The cash value remains stable in the event of index declines, allowing for potential growth when the market recovers.
4. Flexibility: IUL policies offer flexibility in premium payments, death benefit amounts, and the potential to adjust the cash value growth strategy over time.

Variable Universal Life Insurance (VUL)

Variable universal life insurance (VUL) is an alternative form of permanent life insurance that empowers policyholders to allocate the cash value portion into various investment options, including stocks, bonds, or mutual funds. Here are the key aspects of VUL:

1. Investment Options: VUL policies offer a range of investment options known as sub-accounts. Policyholders can allocate their cash value among these sub-accounts, enabling them to potentially earn higher returns based on the performance of the chosen investments.
2. Investment Risks: Unlike IUL, the cash value in VUL is subject to market volatility. If the selected investments perform poorly, the cash value may decrease. However, if the investments perform well, the cash value has the potential for significant growth.
3. Flexibility and Control: VUL policies provide flexibility in premium payments, death benefit amounts, and the ability to switch between investment options. This allows policyholders to adapt their coverage and investment strategy to their changing financial goals and risk tolerance.

Considerations and Risks

1. Market Volatility: Both IUL and VUL are subject to market fluctuations, and the cash value growth is tied to the performance of the selected index or investment options. This exposes the cash value to potential losses during market downturns.
2. Policy Costs: Indexed and variable universal life insurance policies often have higher costs compared to traditional whole life insurance. It’s important to consider premium payments, fees, and charges associated with the policies.
3. Investment Expertise: With VUL, policyholders assume the responsibility of managing their investment allocations. This requires knowledge and expertise in monitoring and adjusting investment options based on market conditions.
4. Policy Performance: The performance of an IUL policy is dependent on the performance of the chosen index, while VUL policy performance relies on the performance of the selected investments. Both can be influenced by factors beyond policyholders’ control.

Conclusion

Indexed universal life insurance (IUL) and variable universal life insurance (VUL) provide policyholders with the opportunity to grow their cash value by linking it to market performance.

IUL policies track specific market indexes, providing potential growth while offering downside protection. VUL policies allow policyholders to invest the cash value in a range of investment options, offering the potential for higher returns but with greater investment risks.

It’s important to consider the benefits, costs, and risks associated with these policies and assess your risk tolerance, financial goals, and investment expertise before choosing between IUL and VUL. Consulting with a financial advisor or insurance professional can help you make an informed decision tailored to your individual needs.