Those shopping for the right life insurance policy have a wide array of
choices, ranging from cheap term life insurance to expensive whole life
insurance policies. When it comes to permanent life insurance policies,
two popular options are whole life insurance and index universal life
insurance (IUL). Individuals deciding between these options should
carefully examine their needs before committing to a life-long decision.
In this article, we’ll take a look at the key differences between these
policies and some tips for individuals trying to decide between them.
WHOLE LIFE INSURANCE
Whole life insurance policies have been around for decades, guarantee a
benefit, and have predictable premium payments that don’t increase with
age. In general, these policies are considered the safest option for
those looking to provide for their families after death.
BENEFITS
- Guaranteed benefits
- Fixed premiums that don’t increase with age
- Option to pay up face value in 10 years, 20 years, or at age 65
- Option to borrow against if needed later in life
DRAWBACKS
- Interest rate may not be guaranteed
- Potential opportunity cost with low interest rates
- Premiums aren’t flexible and must be paid consistently
INDEXED UNIVERSAL LIFE INSURANCE
Indexed universal life insurance policies are relatively new policies
that provide a guaranteed benefit, earning potential tied to an equity
index, and flexible premium payments. In general, these policies are
riskier and more complex options geared towards retirement planning.
BENEFITS
- Guaranteed benefits
- Flexible premium payments
- Potential for higher interest earnings
- Option to borrow against later in life
DRAWBACKS
- Earnings depend on equity performance
- Potential for premiums to rise over time
- Use of complex derivative investments
DECIDING BETWEEN THE TWO
Whole life insurance is designed to be exactly that – life insurance. In
many ways, indexed universal life insurance policies are retirement
planning vehicles. Cash inside of these policies grows on a tax-deferred
basis and the cash value can be used to pay premiums. During
retirement, policyholders can take tax-free distributions to help cover
the costs of retirement for those that have already maxed out their Roth
IRA and other options.
It’s also important to consider the use of derivatives by indexed
universal life insurers. Since a call option is inherently capped at a
certain level or expire worthless, IUL policies have limitations to the
maximum returns during good years and limit downside to 0% returns
during bad years. Insurance providers touting high returns for IUL
policies may be trying to take advantage of “recency bias” if equity
indexes have been performing well as of late.
Aside from reading the fine print, IUL policyholders should not rely on
high equity index returns to fund their life insurance over time. High
returns in some years can lead to policyholder neglecting to fund the
cash value of the policy, which could lead to a lapse in coverage later
in life if returns aren’t quite as good. Taking policy loans from the
cash value and paying interest can also be a risky endeavor if the
credited interest doesn’t cover the costs of the loan.
THE BOTTOM LINE
Individual shopping for a life insurance policies have a number of
different options. While term life insurance is generally the cheapest
option, whole life and indexed universal life insurance policies provide
a cash value alternative. Whole life is generally the safest route for
those looking for something predictable and reliable, while IUL policies
provide an interesting retirement planning vehicle with greater upside
potential and tax advantages.
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