Indexed universal life

Indexed universal life, explained without the sales pitch

Indexed universal life, or IUL, is a form of permanent life insurance. Its cash value may be credited with interest that is linked to the movement of an external index, using a formula set by the policy. It is one of the more complex products in life insurance and is often oversold. Here is how it works, including the parts that tend to get skipped.

See whether IUL fits the goal

Cornerstone Capital is an independent life insurance brokerage, not an insurer. Carriers make underwriting decisions, and approval is never guaranteed. This form does not apply for coverage.

This page is for you if

Someone has shown you an IUL illustration, or is about to.
You want a lifelong death benefit and are weighing flexibility against complexity.
You would rather understand the limits before the upside.

Before anything else

Questions to ask yourself

Talk these through with a broker

Is your main goal a death benefit, and do you need it for life?
Have you covered your basic protection needs and other savings priorities first?
Can you fund the policy consistently for many years, and add more if it is needed?
Do you understand how caps, participation rates and spreads limit what is credited?
Have you seen an illustration at lower assumed rates, not only the most favorable one?
Are you willing to review the policy every year?

01The problem

A product that is easy to oversell

Indexed universal life is usually introduced with its most attractive scenario: years of steady credited interest, loans in retirement, a death benefit at the end. That scenario depends on assumptions, and the assumptions are the part that gets the least attention.

The useful questions are the dull ones. What are the charges? What happens in a flat decade? How much more would I have to pay in if the cap drops? What does the lower-rate illustration show?

02The tool

Permanent life insurance with index-linked crediting

IUL is universal life. Premiums go in, charges come out every month, and the remaining cash value may be credited with interest tied to the movement of an external index under a formula the insurer sets. You do not own the index or anything in it.

Its first job is the death benefit. Everything else about it is a feature with limits attached.

03The mechanics

How it works

A permanent policy first

IUL is permanent life insurance with a death benefit and a cash value account. Premiums are flexible within limits. Each month, the cost of insurance and other policy charges are deducted from the cash value.

Its primary purpose is the death benefit. Cash value is a feature of the policy, not a substitute for a retirement plan or an investment account.

How index crediting works

You can usually allocate cash value between a fixed account and one or more indexed accounts. In an indexed account, interest may be credited based on the change in an external index over a set period, calculated under the policy's formula.

The policy is not invested in the index. You do not own shares or funds, and index dividends are typically not included in the calculation.

Caps, participation rates and spreads

The formula limits how much of an index's gain is credited. A cap sets a maximum rate. A participation rate credits only a percentage of the index change. A spread subtracts a set amount before anything is credited. A policy may use one or several of these.

The insurer can generally change caps, participation rates and spreads over time, within minimums and maximums stated in the contract. What is credited in the future may be lower than what is available today.

What the floor does and does not do

Many indexed accounts have a floor, often 0%, meaning index-linked interest for a period will not be negative. The floor applies to the interest credited. It does not stop policy charges.

Charges are deducted whether or not any interest is credited. In a period with 0% credited, the cash value goes down by the amount of those charges. A 0% floor does not mean the policy cannot lose cash value.

Funding, loans and lapse

The premium needed to keep an IUL in force can change. If credited interest is lower than assumed, or charges increase, more premium may be required than was first planned.

Loans and withdrawals reduce the cash value and the death benefit and may have tax consequences. Loan interest accrues. A policy that is underfunded, or whose loans are not managed carefully, can lapse. A lapse with a loan outstanding may result in taxable income and the loss of coverage.

What you may have heard

Said often. Worth a second look.

When the market goes up you make money. When it goes down you lose nothing.

What is actually trueThe 0 percent floor applies to the interest credited for a period. It does not apply to charges. Cost of insurance and policy charges come out every month whether or not any interest is credited, so cash value can go down in a year when the index is flat or negative. Gains are also limited by caps, participation rates and spreads the insurer can change.

It is a retirement plan that replaces a 401(k).

What is actually trueIt is life insurance. Loans against cash value are possible where the contract permits, they accrue interest, and they can cause a lapse with tax consequences if they are not managed. Results depend on policy design, premiums, costs, crediting, loan terms and how long the policy stays in force.

Concept names decoded

The names this goes by

Names you may have heard for what is on this page. Open one to see what it is and what it does not promise.

Marketing nameIUL Accumulation Strategies“Market upside with no downside.”

This is a planning or marketing description, not a type of policy. It refers to a permanent cash value life insurance policy used together with policy loans. Results depend on policy design, premiums, costs, dividends or crediting where applicable, loan terms and how long the policy stays in force.

What it actually is: Funding an indexed universal life policy above the minimum so more cash value is exposed to index-linked crediting.
Common policy types: Indexed universal life.
What it may accomplish: Cash value growth linked to an index, within caps, participation rates and spreads, alongside a death benefit.
What it does not guarantee: That cash value cannot fall. A 0 percent floor limits the interest credited. Charges continue and reduce cash value in a flat or negative period. Caps and rates can change.

Questions to ask

What are the current cap and participation rate, and what are the contractual minimums?
What are total charges in years one through ten?
How much can I fund before the policy becomes a modified endowment contract?

Where this fits

Marketing nameLIRP“A life insurance retirement plan, sometimes pitched as retirement income without taxes.”

What it actually is: Short for life insurance retirement plan. It is not a retirement plan under federal law. It is a permanent cash value policy funded with the intent to take loans or withdrawals later in life.
Common policy types: Indexed universal life or whole life.
What it may accomplish: A death benefit, with cash value that may supplement other income through loans or withdrawals where the contract permits.
What it does not guarantee: Retirement income, or any particular tax result. Cash value generally grows tax deferred under current federal law, and withdrawals and loans can have tax consequences, particularly on lapse, surrender or modified endowment contract status.

Questions to ask

Have I used workplace and individual retirement accounts first?
What does the lower-rate illustration show?
What happens to the plan, and the taxes, if the policy lapses in my seventies?

Where this fits

Marketing nameBe Your Own Bank“Borrowing from my policy instead of a bank.”

What it actually is: A phrase for taking loans against a permanent policy's cash value. The lender is the insurance company, and the cash value is the collateral.
Common policy types: Whole life, universal life or indexed universal life.
What it may accomplish: Access to funds without a credit application, where the contract permits.
What it does not guarantee: That borrowing costs nothing. Loan interest accrues, the death benefit is reduced by what is owed, and a lapse with a loan outstanding can create taxable income.

Questions to ask

What is the loan interest rate, and can it change?
How does a loan affect how the policy is credited?
What happens to the policy if the loan grows larger than the cash value?

Where this fits

See every name decoded

04Trade-offs

What it does, and what it does not

Advantages

A death benefit that is designed to last for life if the policy is adequately funded.
Potential for index-linked interest, within the limits set by the policy.
A floor on index-linked interest for each crediting period.
Flexible premiums and, within limits, an adjustable death benefit.
Cash value generally grows tax deferred under current federal law, and death benefits are generally excluded from a beneficiary's federal gross income, subject to exceptions.

Limitations

Caps, participation rates and spreads limit crediting, and the insurer can change them within contractual bounds.
Cash value can decline when charges exceed the interest credited, even with a 0% floor.
Premium requirements can change, and the policy can lapse if it is underfunded.
Loans and withdrawals reduce cash value and death benefit, may have tax consequences, and can cause a lapse if poorly managed.
Illustrations rely on assumptions. Illustrated non-guaranteed values are projections, not guarantees, and actual results may be lower.
Surrender charges can apply for many years, and the product is complex enough to need regular review.

05Fit

Who it may fit, and who it may not

Who it may fit

People with a lifelong need for a death benefit who also value flexibility.
Those who have already addressed basic protection, emergency savings and workplace retirement plans.
Households with stable income who can fund a policy well over a long period.
People who will review the policy annually and adjust funding when needed.

Who it may not fit

Anyone whose main goal is the most death benefit for the premium.
People with an uncertain or tight budget.
Those looking for an investment, or a replacement for a retirement account.
Anyone who expects to need the money in the near term.
People who prefer fixed terms and few moving parts.

How Cornerstone works

We are an independent brokerage, so we can look at more than one carrier, subject to appointments, product availability, licensing and eligibility. We ask about your situation first and explain the trade-offs. Keeping what you have is a fine outcome.

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Important to know

Indexed universal life is permanent life insurance, not a security and not an investment in any index. Interest crediting may be linked to an external index under the policy's formula and is limited by caps, participation rates and spreads. A 0% floor does not protect cash value from policy charges, which continue.

Policy illustrations are not contracts. Illustrated non-guaranteed values are not guarantees and are not predictions of future performance. Any contractual guarantees are backed by the claims-paying ability of the issuing insurer.

Loans and withdrawals reduce cash value and death benefit, may cause the policy to lapse, and may have tax consequences. Modified endowment contract (MEC) rules apply, and a policy that becomes a MEC is taxed differently on distributions. Tax treatment depends on your circumstances and on current law, which can change. Consult qualified tax and legal professionals.

Eligibility and premium depend on age, health, underwriting and carrier criteria. Approval is never guaranteed, and premium requirements may change over the life of the policy.

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