When people think about a personal financial plan, they often think of 401(k)s and IRA, but fewer people remember to include life insurance. While this type of insurance is primarily designed to provide financial support to your loved ones in the event of an untimely death, it can also be a part of a well-rounded financial planning strategy.

Indexed Universal Life insurance (IUL) is one way to create a balance between potential market-linked returns and the security of a guaranteed minimum interest rate. This type of policy allows you to increase or decrease premium payments based on investment returns, eventually enabling many policyholders to pay all premiums using the policy’s cash value. However, it's a complex financial product that requires careful consideration and understanding.

What Is It?

Indexed universal life (IUL) is a type of insurance that offers the benefits of traditional life insurance protection combined with the potential to use a portion of your premium payment to grow in an “investment-like” fund. IUL cash value allows for growth based on a stock index based on a set grouping of various stocks. You may adjust your premium as the cash value grows, with the potential to reach a point in which all premiums can be paid for by your built-up cash value, known as a zero-cost policy.

IUL is a permanent life insurance policy that provides death benefit protection during the lifetime of the insured individual as long premiums are paid. Conversely, term life insurance is limited to a specific period (term), and benefits are typically reduced or eliminated once that term is over.

Like most life insurance policies, IUL pays out a tax-free death benefit to your beneficiaries when you die.

When is IUL a Good Idea?

The cash value growth in an IUL policy is tax-deferred. That means the policyholder can make money on the market without paying capital gains taxes as long as those gains remain within the policy.

Like many permanent life insurance policies, IULs offer the option to make withdrawals or take loans from the accumulated cash value. If they are structured correctly, those withdrawals are not subject to income tax. Beyond those withdrawals, the loans taken from the policy can also be tax-free. Each insurance company has rules and guidelines for policy loans, and those regulations may vary among carriers, so be sure to be very familiar with your policy's provisions.

Importantly, if an IUL policy becomes a Modified Endowment Contract (MEC), it can affect the tax treatment of policy loans. To avoid MEC status, be cautious about making excessive premium payments that could trigger this classification.  Insurance carriers generally re-test the policy and typically notify you if you are in danger of violating the MEC rules. Tax laws and regulations can change, and the tax treatment of IUL policy loans may vary depending on your individual circumstances. Consult a tax professional to assess your situation.

Who Should Consider Making an IUL Policy Part of Their Financial Plan?

Indexed Universal Life (IUL) insurance policies have many benefits but don't make sense for everyone. They are most suitable for individuals with specific financial goals and needs.

Potentially a Good Fit if You're Seeking Permanent Life Insurance

An IUL is a form of permanent life insurance, so it may be an attractive option if you are considering lifelong coverage.

Suited to Risk-Averse Individuals

Unlike most types of investments, IUL policies come with a guaranteed minimum interest rate or floor. So, if the stock market index performs poorly, the policy's cash value won't decrease. This provides some exposure to market gains without taking on the full risk of market losses. In exchange for the protection of a market floor, these contracts usually have a ceiling on the earnings (a cap rate), which is reset annually.

Attractive to People Focused on the Long-Term

IUL policies come with fewer risks, which means there are no short-term gains. But if you are looking for tax-advantaged growth over time, IULs may be a viable supplement to retirement savings and provide a financial legacy for your heirs.

Tax Advantages for High-Income Earners

For higher-income people looking for tax advantages, IUL's tax-deferred growth of the cash value and tax-free withdrawals or loans may provide some reduced exposure to taxation.

Provides Some Balance to Variable Incomes

IULs ultimately provide flexibility of premium payments matched with the potential for market-linked returns. This might make it an attractive financial tool for individuals who need to manage variable income streams, such as business owners or freelancers.

An Estate Planning and Wealth Transfer Tool

Even though IULs have many features and benefits that differentiate it from other policies, it is still a life insurance policy. This means that, in most cases, the policyholder can pass on wealth to heirs or beneficiaries tax-free.

Want to Learn More?

IUL policies are complex financial products, and their suitability depends on an individual's unique financial situation, risk tolerance, and goals. Before purchasing an IUL policy, it's recommended to consult with a qualified financial advisor who can help you evaluate whether this type of policy aligns with your overall financial plan and objectives. Contact Mark@MirusFinancialPartners to determine if IULs make sense with your long-term financial goals.