Indexed universal life pros
Like all financial products, IUL policies have some benefits. Here are a few worth knowing about.
Can act as "forced savings"
For someone who doesn't trust themselves to save money, an IUL acts as a forced savings account. Because part of each premium goes toward cash value, once the premium is out of their hands, the insurance company does the rest.
Offers some tax benefits
IUL death benefits are distributed tax free to beneficiaries. In addition, the policyholder can withdraw up to the amount they have contributed toward cash accumulated tax free. Once they begin withdrawing earnings on the money, funds are taxed as regular income.
Allows access to cash value
If a policyholder needs money and their IUL has accumulated enough cash, they may borrow against that money. If they fail to repay the loan with interest, the outstanding cash value will be subtracted from the policy death benefit.
Provides lifelong death benefit
Say a person purchases an IUL in their early 30s but is diagnosed with a rare disease 30 years later. As long as that person pays their premiums, they continue to be covered, regardless of their health.
Indexed universal life cons
Unfortunately, IUL insurance also has more than its fair share of disadvantages. Here are a few to be aware of.
Premiums increase with age
As a person grows older, the odds of dying increase. For that reason, insurance companies raise the cost of IUL insurance premiums by as much as 8% to 10% annually after the age of 50.
Fees can erode growth
From the moment a policyholder pays their first premium, fees nibble away at any profits they may gain. To understand how, it helps to understand how a premium load works. According to the International Risk Management Institute, Inc., a premium load is the percentage of a policyholder's premium that is deducted to cover policy expenses.
Here's a sampling of the types of fees a policyholder can expect to pay:
- Sales commission: The agent who sells the policy collects a commission from their company and that commission comes out of the policyholder's premium.
- Sales charges: Fees are charged for how much it costs the insurance company to sell the policy and to cover state and local taxes.
- Administration fee: This covers the cost of maintaining the policy and pays for everything from accounting to recordkeeping.
- Mortality charge: When a person buys a policy, the insurance company estimates they will live to be a specific age, and they count on collecting premiums for at least that long. If a policyholder dies before that, the company sees it as losing out on potential premiums. To protect itself, it collects another fee called a mortality charge.
- Surrender charge: This fee is deducted from cash value if a policyholder terminates their policy during the surrender charge period.
According to LIMRA -- the not-for-profit research association for the financial services industry -- sales of IULs are predicted to be up 11% in 2021. While there could be many reasons for the increase, one reason may be the tremendous fees collected by the insurance industry each time an IUL policy is sold and maintained.
Withdrawals can cause the policy to lapse
Imagine someone purchases an IUL policy in their 30s or 40s, hoping it will help fund their retirement one day. In their 50s, they lose their job and can't pay the premium. They contact their insurance company and are happy to learn that their premiums can be paid from the cash accumulated in their account. The following year, they become ill and are never able to return to work full-time. The policy lapses, and the policyholder is not only without death benefit protection, but they lose everything they have paid into the policy.
IUL vs. 401(k)
One of the best ways to determine whether an IUL is a good use of money is to compare it to other standard investment vehicles, like 401(k)s. Here's a quick breakdown of how they compare:
