What Is Indexed Universal Life Insurance and How Does it Work?

Indexed universal life insurance (IUL) is a permanent life insurance policy that provides a death benefit and a cash value component. The cash value is tied to a market index, allowing for potential growth.

IUL offers flexibility in premium payments, death benefits and investment options. The policy's cash value grows tax-deferred, and you can access it through loans or withdrawals. The cash value links to a market index, letting you participate in market gains without directly investing in the stock market.

Cash value is the investment portion of your life insurance policy that accumulates over time. Unlike term life insurance, which only provides a death benefit, permanent life insurance policies like IUL build cash value you can borrow against or withdraw during your lifetime.

Here's a breakdown of indexed universal life insurance pros and cons:

IUL isn't right for everyone. Consider whether it aligns with your needs, goals and risk tolerance.

Many major life insurance companies offer indexed universal life insurance policies and leading providers include:

• Nationwide: Offers indexed universal life with various index options
• Pacific Life: Provides IUL policies with multiple crediting strategies
• Prudential: Features indexed universal life with flexible premium options
• Northwestern Mutual: Offers IUL with strong financial ratings and comprehensive support
• Transamerica: Offers IUL with competitive participation rates
• Lincoln Financial: Provides indexed universal life with various index choices
• Mutual of Omaha: Features IUL policies with flexible benefit options
• Allianz: Offers IUL policies with different accumulation strategies
• American General: Features indexed universal life with flexible benefits

IUL premiums vary significantly based on your age, health, coverage amount, and the specific policy features you choose. Here are rough monthly cost estimates for a $2 million IUL policy for healthy, non-smoking individuals:

By Age:

• Age 30: $1,200 to $2,000 per month
• Age 40: $2,000 to $3,200 per month
• Age 50: $3,200 to $4,800 per month
• Age 60: $6,000 to $10,000 per month

Factors That Affect Your Cost:

• Age: Premiums increase significantly with age
• Health: Medical conditions can substantially increase costs
• Coverage amount: Higher death benefits require higher premiums
• Funding level: Max-funded policies require higher premium payments
• Index options: Some crediting methods may have higher fees

Remember that IUL policies are flexible, so you can adjust your premium payments based on your financial situation. Most financial advisors recommend funding IUL policies adequately to maximize cash value growth relative to insurance costs. For IUL to work effectively as an investment vehicle, many advisors suggest minimum annual contributions of $10,000 or more.

To choose the right insurance strategy, understand the differences between an indexed universal life policy and other types of life insurance:

Indexed Universal Life Insurance vs. Universal Life Insurance

Key difference: How your cash value grows.

• IUL: Your cash value growth is tied to a stock market index (like the S&P 500). You get market-linked returns with caps (maximum gains) and floors (minimum losses, usually 0%). This means potential for higher returns but more complexity. Universal Life: Your cash value grows at a fixed interest rate set by the insurance company. You get steady, predictable growth without market risk, but lower return potential.

Variable Universal Life Insurance vs. Indexed Universal Life

Key difference: How much market risk you take.

• Variable Universal Life (VUL): You directly invest your cash value in mutual fund-like accounts. You can potentially earn higher returns but can also lose money if investments perform poorly. No downside protection. IUL: You get market-linked returns without direct market exposure. The floor (usually 0%) protects you from losses, but caps limit your maximum gains. More protection, less upside potential.

While IUL offers benefits, it isn't right for everyone. Here are other life insurance options: 

• Whole life insurance offers guaranteed cash value growth and fixed premiums. Cash value growth is guaranteed and premiums stay constant, offering predictability and security but often at a higher cost.
• Term life insurance provides pure life insurance protection without cash value. It covers a specific term, such as 10, 20 or 30 years, and is generally more affordable than other options. It suits those seeking temporary protection without investment considerations.
• Investment accounts: Separate investment accounts, such as mutual funds or individual retirement accounts (IRAs), provide investment opportunities without linking them to life insurance. This approach allows for targeted investment strategies and diverse options without life insurance's combined benefits.

Different IUL strategies offer various options with specific advantages and challenges:

Max-funded IUL optimizes cash value growth by maximizing premium payments up to the limits without turning the policy into a Modified Endowment Contract (MEC). This approach quickly builds cash value, creating a substantial financial asset accessible during the policyholder's lifetime.

A compound interest IUL account leverages compound interest to increase the policy's cash value over time. This account is typically linked to a favorable interest crediting method. By reinvesting earned interest, the cash value grows exponentially over time, enhancing the policy's overall financial yield.

Fixed-indexed universal life insurance provides a stable growth rate by linking the cash value to a fixed index rather than more volatile equity markets. This conservative strategy offers predictable returns and less risk, which suits policyholders seeking stability over speculative gains.

Equity-indexed universal life insurance links cash value growth to equity market performance, offering higher returns but introducing more risk. Protective floors mitigate losses by setting a minimum interest crediting rate (typically 0%), but exposure to volatile equity markets means the policy's value can fluctuate substantially.

Answers to frequently asked questions about IUL to help you understand this coverage and determine if it benefits you.