Indexed universal life, or IUL, is a type of permanent life insurance. Like other universal life policies, it offers flexible premiums and an adjustable death benefit. What makes it "indexed" is how interest is credited to its cash value.
Cash value is an amount inside the policy. It grows when interest is credited and shrinks as policy charges come out. Instead of a fixed interest rate, the carrier credits interest based on the movement of a market index, such as the S&P 500. That's subject to a floor, commonly 0%, and a cap or participation rate. The floor is the minimum interest you can be credited, and the cap is the maximum. A participation rate is the share of the index's rise used to figure your interest.
It's important to be clear about what that means. Your money is not invested in the stock market, and you don't own the index. The insurance company uses the index as a formula for how much interest to credit. In a year the index rises, you're credited up to the cap. In a year it falls, you're credited the floor. The policy's internal charges still come out of the cash value either way.
IUL is a more complex product than term or whole life, and it's not right for everyone. It tends to suit people with a permanent need for coverage. It's a fit only if you understand that the illustrated cash value is a projection, not a promise. An illustration is the carrier's hypothetical example of how the policy's values could change over time. I walk through the moving parts slowly and in plain English before anyone applies.
Important to know about indexed universal life insurance
- Indexed universal life insurance is a life insurance policy, not an investment.
- Cash value is credited based on the performance of an external index. The policy does not participate directly in any stock or equity investment.
- Caps, participation rates and spreads are set by the carrier and may change.
- Policy charges apply regardless of index performance.
- Insufficient premiums can cause the policy to lapse.
- Illustrated values are hypothetical and not guaranteed.
- Loans and withdrawals reduce the cash value and death benefit and may have tax consequences.
- A policy funded above IRS limits becomes a modified endowment contract, which changes how loans and withdrawals are taxed.
- Guarantees are backed by the claims-paying ability of the issuing insurer.