Coverage · Indexed Universal Life
A floor under the losses, a ceiling over the gains.
Permanent coverage with a cash value credited according to the movement of an index. The policy is not invested in the index, holds no shares, and cannot lose account value when the market falls.
How the crediting actually works.
The carrier takes your premium, deducts the cost of insurance and policy charges, and places the remainder in the cash value. Most of that money sits in the carrier’s general account, invested conservatively and largely in bonds. A small portion buys options on the index, most often the S&P 500.
At the end of each crediting period, usually a year, the carrier measures the index movement and applies interest according to three settings: a floor, a cap and a participation rate. Two further details decide what your return actually looks like. Almost every IUL excludes dividends from the index calculation, and most policies measure the index point to point across the period, so what happened in between does not count.
Caps and participation rates are not guaranteed for the life of the policy. The carrier sets them and can change them, subject to a contractual minimum that usually sits far below the rate at issue. A policy sold on a 10% cap can be renewing at 6% a decade later with nothing improper having happened.
The three settings
What decides the number you are credited.
The floor
The minimum credited in a period, commonly 0%. If the index falls 30%, the account is credited 0% rather than losing 30%. Policy charges still come out that year, so a 0% credit is not a flat year for the cash value.
The cap
The maximum credited. If the cap is 9% and the index gains 22%, you receive 9%. This is the setting that pays for the floor, and the one most likely to move over time.
The participation rate
The share of the index movement used before any cap applies. At a 70% participation rate, a 10% index gain credits 7%.
The crediting method
Annual point to point is the most common. Monthly averaging, monthly point to point and multi-year methods all behave differently in the same market, so the method belongs in the comparison.
What the regulators changed.
For years the problem with this product was the illustration rather than the contract. Carriers could project a hypothetical rate of return across decades, and the result made an IUL look like it produced returns it had no way of guaranteeing.
The National Association of Insurance Commissioners addressed it in two rounds. Actuarial Guideline 49 arrived in 2015 and set a method for calculating the maximum illustrated rate. Actuarial Guideline 49-A tightened it and took effect at the beginning of 2021. It requires a single benchmark index account across all strategies in a policy, and caps that benchmark, which “cannot exceed 145 percent of annual net investment earned rate.” It also cut the illustrated advantage from borrowing, “reducing the difference in the loan interest rate credits and loan interest rate charges from 100 basis points to 50.”
The purpose, as the Society of Actuaries described it, was to ensure “that products with enhancements such as multipliers, cap buy-ups, and so on would not show better results than non-enhanced products.” An illustration produced after 2021 is meaningfully more conservative than one produced before. If somebody is showing you a projection, it is worth knowing what year the software is from.
Reading an illustration
The column nobody points at.
An illustration is a projection, not a promise. Two columns matter more than the one in the sales conversation.
- The guaranteed columnWhat happens if the carrier credits the contractual minimum and charges the maximum permitted cost of insurance. It usually looks bleak, and it is the only column the carrier is contractually bound to.
- The illustrated rateAsk what it is, then ask what the policy looks like two points lower. A policy that only works at 6.5% and fails at 5% has no margin in it.
- The premium assumptionMost IUL illustrations assume a specific premium paid every year for decades. Paying less than illustrated does not simply slow the growth. It can put the policy on a path to lapse.
- The chargesCost of insurance rises with age, and most policies allow the carrier to increase it up to a contractual maximum. Charges come out whether the index went up or down.
What is the overfunding limit?
Where an IUL is bought largely for its cash value it gets funded as heavily as the tax code allows, and there is a hard line. Internal Revenue Code section 7702A defines a modified endowment contract as a policy that fails the seven-pay test, which happens if the premium paid in the first seven contract years exceeds the net level premiums that would have paid the contract up in seven annual payments.
Cross that line and the treatment of living benefits changes. Loans and withdrawals come out gain-first and are taxable to that extent, with a 10% penalty before age 59 and a half. The death benefit stays income tax free. The reason most people bought the policy does not. A policy meant to be overfunded has to be designed against that limit deliberately, at application rather than in year four.
Who is indexed universal life actually for?
It is a reasonable instrument for a permanent death benefit need, a long time horizon, and a premium the household can sustain for decades. For somebody already funding tax-advantaged retirement accounts to the limit, the additional tax-deferred room can be worth something.
It is the wrong instrument for a temporary need, which term insurance covers at a fraction of the cost. It is wrong on a tight budget, because an underfunded IUL lapses in its second decade and takes the premiums with it. And it is wrong as a retirement account substitute, because it is life insurance with an account attached and it carries insurance charges a retirement account does not.
What should I ask before signing?
What is the current cap and the contractual minimum cap. What is the participation rate and can the carrier change it. Does the index calculation include dividends. What does the guaranteed column show at year 20 and year 30. What happens if I pay the illustrated premium for ten years and then stop. Is this policy designed to be a modified endowment contract, and if not, how close to the line is it. What is the surrender charge schedule and how long does it run.
Vague answers to any of those are information in themselves. There is a fuller walk-through in what indexed universal life actually is.
Your own coverage
Have it priced across 20+ carriers.
Tell us what you already hold and what you are trying to protect. One of our team members will reach out within 24 to 48 hours, and the client is never charged a fee.