Those who buy the right life insurance policy have a wide variety of options, ranging from cheap life insurance to expensive permanent life insurance policy. in what
IUL vs. Whole Life: An Overview
Those who buy the right life insurance policy have a wide variety of options, ranging from cheap life insurance to expensive permanent life insurance policies. With regard to the latter, two popular options are whole life insurance and the universal life insurance index (IUL). Individuals who decide between these options must carefully examine their needs before committing to a lifelong decision.
In this article, we’ll look at the main differences between these policies and some tips for people trying to decide between them. (For detailed information, see “Life insurance: putting a price on peace of mind”).
- Permanent life insurance provides death benefit coverage for the life of the policyholder.
- Permanent policies accumulate cash value that can be used for disbursements such as retirement income or emergency savings.
- Indexed universal life (IUL) policies have flexible payments with cash accumulation tied to the performance of a stock index.
Whole Life Insurance
Whole life insurance policies have been around for decades. In general, these policies are considered the safest option for anyone looking to support their family after death.
- Guaranteed death benefits
- Fixed premiums that don’t increase with age
- Option to pay the face value in 10 years, 20 years or 65 years
- Option to borrow against cash value if necessary later
- Interest and cash disbursements may be exempt from income tax
Problems with whole life insurance
- The interest rate may not be guaranteed (although there is often a minimum rate)
- Premiums are not flexible and must be paid consistently.
Indexed universal life insurance
Indexed universal life insurance policies are relatively new. As its name implies, your earning potential is tied to a stock index. In general, these policies are riskier and more complex.
Indexed universal life insurance policies give policyholders the option to allocate all or part of their net premiums (after paying insurance coverage and expenses) to a cash account. This account credits interest based on the performance of an underlying index with a 0% return floor and a cap rate and/or return share limit.
The dynamics start to get a little darker when you look at how the index’s exposure is built. Rather than buying shares outright, the insurance company typically enters into option contracts using a portion of the policy premium, which allows them to pass along positive gains without the negative losses—but at the cost of additional counter party risk.
Many life insurance companies offer minimum cap rates between 1% and 4% and participation rates around 50%, although some offer unsecured capacity rates around 10% to 14% and participation rates above 100% in sales materials, according to a report of the top life insurance companies. If an underlying index returns 20%, the policyholder can only get a return of 10% to 12% with these limits. The use of stock options also eliminates dividends from any index return calculation, which generally accounts for 2% to 4% of the total market return. Without these returns, policyholders can generate a lower return than benchmarks.
- guaranteed benefits
- Flexible premium payments
- Potential for higher interest earnings
- Option to borrow against policy later in life
Problems with indexed universal life insurance
- Earnings depend on equity performance
- If the index falls, returns may be lower, although there are often floors to avoid extreme losses.
- Potential for premiums to increase over time
- Use of complex investments in derivatives
- higher expenses
- The death benefit may be reduced or forfeited if premium payments fall short of performance.
Also read :Term vs permanent life insurance
Is IUL better than whole life?
Whole life insurance is designed to be just that life insurance. Indexed universal life insurance policies, on the other hand, are more like retirement income vehicles. The money within these policies grows tax-deferred and can be used to pay premiums. In addition, during retirement, policyholders can receive tax-free distributions of the accumulated cash value to help cover any type of expense, useful for those who have already maxed out on the Roth IRA and other options. In fact, many policies are sold based on the concept of cash value accumulation rather than a guaranteed death benefit.
It is also important to consider the use of derivatives by indexed universal life insurers. Because a call option is inherently limited to a certain level or expires worthless, IUL’s policies limit maximum returns during good years and limit the downside to 0% returns during bad years. Insurance providers that report high returns for IUL policies may be trying to take advantage of the “recency bias” if stock indices are doing well lately.
Some IULs also come with guaranteed contractual user benefits, which may actually provide guaranteed benefits comparable to general account products. Still, IUL policyholders should not rely on high stock index returns to fund their life insurance over time. High returns in a few years can cause policyholders to fail to fund the policy’s cash value, which can lead to a lapse of coverage later in life if returns are not as good. Borrowing with cash value policies and paying interest can also be a risky venture if the interest credited does not cover the cost of borrowing.
Individuals who buy permanent life insurance, which offers a cash component and insurance coverage, have several different options. Whole life is generally the safest route for those looking for something predictable and reliable, while IUL’s policies provide an interesting retirement planning vehicle with the greatest potential for advantage and tax advantages.