When you’re making plans for your future, it’s important to invest money to grow your wealth. As you do, you also want to make sure your family is protected in case something happens to you.
There are many different financial products to consider to help you achieve your aim of growing your nest egg and providing for those you love. One of those financial products Americans often consider is whole life insurance, which offers death benefit protection. People often spend time looking for the best life insurance, and they may have different goals when selecting a particular plan.
Whole life insurance can be a costlier alternative to term life insurance. Buying whole life insurance products with a life insurance company coverage generally costs more not only because the policy remains in effect indefinitely, unlike a term life insurance policy, but also because there’s an investment component to these policies. Premiums start out at a higher cost to cover insurance, and some of that money is invested. Another term used to refer to any life insurance policy that doesn’t expire is permanent life insurance.
Whole life policies are conservative investments. There’s little risk of you losing money in most cases. But, with reduced risk comes reduced reward, as the returns you earn on a whole life policy may not always be as generous as the returns you could earn on other investments.
There are different kinds of whole life policies, which are largely distinguished by the way the investment component of the policy works rather than the insurance component. One of those policy types is indexed universal life insurance.
Indexed universal life insurance policies are a type of whole life policy that accrues a cash value based on the performance of different index equities. Indexed universal policies can sometimes provide a reasonable rate of return, but these policies can be complicated, so you need to research your options carefully to decide if they’re worth it as you’re comparing life insurance quotes and potential premium payments.
Getting to Know the Life Insurance Industry
Indexed universal life insurance policies aim to combine the benefits of both whole life policies and term policies.
Term life insurance policies aren’t investment vehicles and don’t provide lifetime coverage. You buy a term life policy for a set duration of time, such as 20 years, and your death benefit only pays out if you die during the term. If you live long enough, your heirs or beneficiaries get nothing from the policy.
Term life policies generally have low premiums as long as you’re healthy when you get covered. And, policyholders who buy them don’t expect to need insurance forever. You’ll have coverage when your loved ones depend upon your income or the services you provide. Once you get older and have money saved and your mortgage paid off, your family presumably won’t need a death benefit if something happens to you.
Whole life policies, on the other hand, are intended to remain in effect for an indefinite period of time. You may need whole life coverage if you expect to always have people who need you, such as if you require a big life insurance payout to cover estate taxes after your death or if you have a disabled child who will always require financial support and long-term care.
When you choose indexed universal life insurance as your whole life policy, you pay a premium for annual renewable term insurance with the premiums based on the life of the insured. Once you’ve paid the premiums for the term life coverage, the remaining money is added to the cash value of your whole life policy. You then earn an interest rate on the cash value. The amount of interest you can earn is based on:
- How an equity index performs. Indexes are groups of investments, such as stocks and bonds. Your money isn’t directly invested in these indexes, but the returns you earn are based on how the indexes perform. For example, your money could be tacked to an index that tracks the S&P 500. If the equity index declines in value, you will not receive any interest.
- The participation rate: This rate is set by the insurance company and it dictates how much of the gains from the index are credited to your policy. For example, if you have a policy with a $20,000 cash value, your policy has a 50% participation rate and the index gains 5%, you would calculate the cash value added to your policy by multiplying 5% x 50% x $20,000 to get $500.
- Any policy guarantees: While you do not receive interest on your policy if the index you are invested in goes down, some indexed universal life insurance policies do guarantee you’ll receive at least a certain minimum rate of return over time. However, this rate is generally fairly low.
It’s important to shop around carefully when considering indexed universal life policies, as the participation rate and guaranteed return – if any – can make a big impact on how much your policy is worth. You’ll also need to compare the costs of coverage, as both pricing and eligibility will vary based on your age, health status, and policy terms.
Benefits of Indexed Universal Life Insurance
Indexed universal life insurance policies can provide a higher rate of return than most other whole life insurance, and premiums may be lower than for other whole life policies. Premiums are lower, however, because you take on more risk – if your indexes perform poorly, you won’t earn much while many other whole life policies promise higher guaranteed rates of return.
While investing is always risky, with an indexed universal life policy, you get access to equity investments without taking on as much risk as investing directly in the stock market. This is especially true if your policy guarantees a minimum rate of return. You can also grow your money invested in the policy without having to pay capital gains taxes on investment income. This makes it easier for your policy to accumulate cash value.
Finally, these life insurance protection policies allow you to invest as much as you’d like, make changes to policy terms including death benefits, and change what your investments. You can even access the money invested at any age without penalty, and your money can pass to your heirs or beneficiaries outside of the probate process and without triggering estate tax.
Disadvantages of Indexed Universal Life Insurance
While indexed universal life insurance policies undoubtedly have some benefits, there are also some big disadvantages to these policies as well. These include:
- No guarantees on returns: There’s no certainty that you’ll earn what you expect with an indexed universal life insurance policy. And, while policies guarantee you’ll earn at least a small return on investment, others have no guarantees at all. Many people who invest in life insurance prefer to avoid this level of uncertainty.
- Caps on returns: Your returns may be capped based on your participation rate. That means you may not earn the full returns that you’d earn if you invested directly in the equity index yourself.
Many people also purchase indexed universal life insurance as part of their estate planning or retirement plan on the assumption the policy will eventually accrue enough cash value that premiums are paid out of the policy and no monthly premium is owed later in life.
But, if the indexes you’re invested in perform poorly and market returns are relatively low, you may owe high premiums without the policy accruing a cash value. if you don’t have enough money invested and don’t pay those costly premiums out of pocket the policy could lapse.
Is Indexed Universal Life Insurance Worth It?
Indexed universal life insurance undoubtedly has some benefits, including providing the option to get flexible whole life insurance coverage that may allow you to earn a better return-on-investment than other life insurance policies and of course it can bring peace of mind.
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But, potential caps on returns and the risk your investments won’t perform as planned are big potential downsides to consider. You should research all your options and shop carefully for the right insurance provider if you decide to get coverage.