YOU ASK:

What are the pros and cons of equity-indexed universal life insurance?

WE ANSWER:

Equity-indexed universal life insurance is a type of policy, which affords the policyholder the opportunity to invest the cash value in index options that follow the movement of an index, such as the Dow Jones Industrial Average.

What are the benefits of equity-indexed universal life insurance?

  • The potential of earning interest credit that is higher than traditional cash-value policies. Certain policies of this type even offer features which compare several indices and give more weight on those performing better.

  • Offers guarantee that yearly returns will not be negative. In this policy, the policyholder is protected in case there is a decline in the index. The value of the contract will not decline because of a declining index. The risks involved are absorbed by the insurer thus protecting the policyholder.

  • Tax advantages: The proceeds provided in the event of death are not taxable and so is the build up of cash values. Earnings that are for retirement or education may also be tax-managed. This is unlike other options like 401(k)s and IRAs which only delay taxation but do not altogether eliminate it. These tax benefits can lead to a relatively better cash flow during retirement.

  • Provides a cheaper death benefit than other policies.

  • Returns on premium are guaranteed. A policyholder may cancel his policy and get back the purchase amount.

  • Offers lifetime insurance without having to make lifetime payments. A consumer may opt to make payments until the age of 65 and yet get coverage up to age 100 or older.

What are the disadvantages of indexed universal life policies?

  • They do not come cheap. Commissions paid to brokers can be substantial and the administrative costs are higher compared to other investments like mutual funds. These costs can eat up the returns.

  • Withdrawing money from a policy will incur high surrender charges. This provision is typically applicable over a 10 to 15 year period or even longer.

  • Mortality charges are required and can be substantial especially if the buyer smokes or has questionable health.

  • May reap low, bond-like returns. Many EIUL carriers invest in bond instruments. This can be a disadvantage to consumers who think stocks offer better returns.

  • The formula used for interest-crediting can be changed. Carriers often do this because they cannot offer long-term assurance on strong returns.

  • Increase in the index does not translate to the same amount of increase in the investment. This is because the returns are capped. Usually the consumer gets only around 80 percent of the increase.

Difference between variable universal life insurance and indexed universal life insurance

The variable universal life or VUL insurance policy offers the possibility of earning more but the risk involved is much greater because there is no protection against downside risk.

On the other hand, indexed UL policies offer the policyholder protection in that the insurance carrier assumes downside risk. In the event the stock market declines, the policyholder is shielded against losses. However, the policyholder does not get the same earning potential as a VUL.

How does indexed universal life insurance compare vs. whole life insurance?

  • In an index-linked UL policy premium payments are flexible while in whole life policy they are fixed.
  • Death benefits in index-linked policies are adjustable while in whole life policies they are fixed.
  • IUL cash values grow with the index but this is subject to caps and participation rates. Whole life cash values have assumed rates usually 3 to 4 percent plus dividends that are non-guaranteed.
  • IUL loan rate is at the discretion of the policyholder which can either be variable or fixed. In a whole life policy the rate is determined by the policy itself.

Do you need index universal life insurance or term life insurance?

Term life insurance will serve your basic needs. It is more affordable and you can choose one that suits you best.

An index-linked policy can be a choice if you are looking for a policy that also affords you to grow your money in a relatively safe way. However, it will cost you more because you are paying for coverage and for the investment. If you have better alternatives to investing, you might as well invest in term life insurance and put the rest of your money in those investment vehicles.

When is equity indexed universal life insurance a good investment?

If you are 30 to 40 years old looking for a safe investment, an EIUL policy might serve you well as you will have the time to build up your cash value. At this age, policyholders also tend to have families who depend greatly on them and thus will find the death benefit an advantage.

In addition, those who have maximized their 401(k)s and IRAs may want to consider this product.

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