What exactly is an Index Universal Life Insurance Policy?
This is an “inbetweener” policy. It’s more expensive than Universal Life, but it is still cheaper than a Whole Life. In many cases, these cost almost the same as a Variable Universal Life Policy. And like Variable Universal Life Policies, this is also invested. So what makes this different from a VUL?
The main difference is how it’s invested, as it states in the name, it is related to the Index. Depending on which Index you choose for your investment, the insurance company will than credit the performance of the Index into your policy as interest. But there are special rules involved that make this completely different.
So what are the Pros and Cons of Index Universal Life Policies?
|These policies actually have a floor of 0%. Meaning if the Index has a negative return, the Insurance Company will not deduct the losses from your account. You can invest without the fear of a loss due to unfavorable stock market conditions.|
|It also shares the same benefits as Variable Universal Policies in the fact that it is tax-deferred savings, and has favorable policy loans.|
|It keeps in pace with inflation.|
|Not all policies have participation rates. Further explained in cons.|
|These policies have a ceiling, usually around 10-13% ceilings. A ceiling is the maximum amount of return that is allowed in a given year. That means that if the Index returned 25% in a given year, the Insurance Company will only credit the policy up to the ceiling (10-13%) and keep the rest of the profits to themselves.|
|These policies may have a participation rate. A Participation rate is the amount that is actually going to be invested/credited. Simply put, if the Insurance Company states that they have a 50% participation rate, that means that out of the money in the separate account, only 50% is invested.|
As an example of a broader view, try to answer this question.
You purchase an Index Policy with a ceiling of 10% and a participation rate of 50%. The policy costs $2000 a year, and you are told that $1000 was used to pay for the cost of insurance. The Stock Market also returned 25% that year. What is your return?
If you thought it was $500, you’re wrong.
If you thought it was $250, you’re wrong.
If you thought it was $200, you’re wrong.
If you thought it was $100, you’re wrong.
If you thought it was $50, you’re right.
How did we get $50?
Out of the $2000 premium, $1000 is actually put in the separate account to be invested. The ceiling is 10%, so even though there was a 25% return, you only receive 10%. And because there is a 50% participation rate, only $500 out of the $1000 is actually invested. Meaning, your return is based off of 10% return on $500.