Kiplinger’s recent article, “What Is Indexed Universal Life Insurance and How Does It Work?” says there are three types of policies within the universal life category: variable universal life, fixed universal life, and indexed universal life (IUL).
IUL is a type of permanent life insurance that provides a death benefit to your beneficiaries. It offers a cash-value component that can increase over time. You typically want to fund an IUL policy over a series of years, typically five to 10, rather than all at once, to maintain its tax-free status. Unlike many insurance policies that require you to keep paying premiums so the policies don’t lapse, an IUL allows you to adjust or even stop paying premiums if your policy’s cash value is sufficient to support the policy costs.
An IUL can grow the cash value by crediting interest to the policy based on the performance of an external market index, like the S&P 500. The cash-value growth based on the underlying index is subject to caps, floors, and participation rates. The policy is never actually invested in the market or index itself, and it doesn’t lose money due to adverse market performance. However, the policy will deduct fees and interest from policy loans yearly. This will reduce your policy's cash value, especially during years in which no interest is credited. You may be able to minimize some costs in the policy by adjusting different parts of the policy.
For example, after you have funded the policy over several years, you may want to lower the death benefit, assuming you don’t need as much coverage, which should help lower some of the internal insurance costs and hopefully help the cash value of the policy increase over time.
An IUL policy’s cash value may grow based on the gross amount, even if you take out a loan.
Therefore, if your policy has a cash value of $100,000, and you take out $15,000 as a loan, the policy still has a gross amount of $100,0000 because the $15,000 is a loan against the policy, allowing the $15,000 to be tax-free.
Now, let’s say that after a year, the policy earns a 10% interest credit. As a result, the policy's cash value would grow by $10,000, not $8,500, because the interest is based on the gross amount of $100,000 despite the loan.
Reference: Kiplinger (May 31, 2023) “What Is Indexed Universal Life Insurance and How Does It Work?”
