Pros & Cons of Indexed Universal Life Insurance

by Emma Watkins

    Indexed universal life insurance is an option you have to leave money behind for a beneficiary following your death. Unlike term life insurance, a universal life insurance policy never expires, and since it is linked to a market index, its benefit amount has the potential to grow. Despite these two favorable elements, weigh all the advantages and disadvantages of owning this type of policy before investing in one.

    The insurance company invests part of the premium you pay in a stock index, and shares the gains with you. Your policy may guarantee a minimum rate of return that ranges from 1 to 2 percent, or may simply promise that no matter how poorly the stock market does, your principal is protected; your money may not grow, but you will not lose any of the capital you invested, either.

    Despite the growth potential that indexed universal life insurance policies offer, they also cap how much you can earn from the company’s investments in a stock index. According to the Wealth Preservation Institute, insurance companies limit your payout to guarantee that they achieve their own profit goal. Thus, with this type of life insurance, your returns do not always reflect what the stock market is paying investors. Insurers may also continue to reduce your maximum allowed earnings annually to raise their profits.

    You can use your indexed life insurance earnings to pay the policy’s premiums, and you also can withdraw money from your life insurance account to reduce your beneficiary’s payout on your death. Your withdrawals are tax-free as long as they don’t exceed the total premiums you have paid up to that point. The policy’s earnings are subject to taxes, which remain deferred until you tap into them.

    As the Internal Revenue Code mandates, life insurance policies, including indexed universal life insurance, offer beneficiaries a lump sum payout of the capital you invested that is not subject to income taxes. The tax-free benefit does not extend to interest and dividends the policy earns while you are alive.

    In his website, financial planner Jeff Rose says that the fees insurance companies charge to invest your money are high and taken upfront from your premiums. By reducing your capital, these commissions slow the pace at which your account’s cash value grows. The protracted growth may cause you to have to pay higher premiums to keep the policy competitive.

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    About the Author

    Emma Watkins writes on finance, fitness and gardening. Her articles and essays have appeared in "Writer's Digest," "The Writer," "From House to Home," "Big Apple Parent" and other online and print venues. Watkins holds a Master of Arts in psychology.

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