If you are given an option between choosing a permanent type of life insurance, then it’s most likely that you deal with indexed universal life insurance vs whole life. This is pretty normal, actually, considering that the life insurance policy comes in various choices. It can be the inexpensive term life insurance to the costly (but more advanced) permanent life insurance.
When you are interested in the permanent life insurance, you would be possibly given two options: the whole life (insurance) policy and the index universal life (insurance) policy (or mostly known as IUL). If you want to choose between these two, you need to know the details of each policy before you can commit to a crucial decision, which can be life-long.
The Basic Facts of Indexed Universal Life Insurance vs Whole Life Policy
When it is about indexed universal life insurance vs whole life, you should know that both of them are included as the varieties of the permanent life (insurance) type. Whole life policies would guarantee benefits with (known) minimum growth and fixed premiums. In the meanwhile, the IUL policy would offer flexible payments, with cash accumulation that is pegged to the equity index performance. Each of them has its own strength and also downsides, so you need to know the details before you can make an educated decision.
About Whole Life Insurance
If you want to be able to decide between indexed universal life insurance vs whole life, it means that you need to understand each of the policy quite well – at least you need to understand the basic facts. The whole life policy is considered the safest and the best option for anyone looking to provide enough financial support for their family after they pass away. It’s crucial that you perform careful research for providers to make sure that they are the best whole insurance providers that are able to offer the best service.
One thing people like about the whole life policy is that it builds cash value. For many, it is their emergency funds if something goes south. You can also take a loan out against your policy. This is possible because there would be a portion (from each premium payment) that would be funneled to a savings component, known as the cash value. Over time, this cash value would increase. You are given the option to either borrow against it or withdraw funds. Keep in mind that the regulations about when or how you can do this would be different from one company to another, and it would also be different from one policy to another. Your insurance company may likely offer guidelines (which you can follow) so you won’t (inadvertently) reduce the death benefit or create a tax burden.
When it comes to indexed universal life insurance vs whole life, price will also play a crucial role. The cost of the policy would depend on some factors, including the numbers of coverage being bought, and others. This kind of policy also offers different payment options. You should be able to get a fixed annual payment, but some companies may provide options so you can pay in quarterly, in monthly basis, or twice a year. Just keep in mind that if you have to pay the premiums more than once within a year, you will likely deal with extra fees.
Based on the explanation from IRS, you won’t be able to deduct the premiums (for the whole life insurance) on tax return. However, your beneficiaries won’t have to be responsible for federal income taxes when they get the death benefits. but any interest that is gained or earned on top of the benefit would be eligible for tax as it would be viewed as taxable income.
There are several good things about this kind of whole life insurance, such as:
- It guarantees death benefits
- It has options to pay the face value up within 10 years, 20 years, or even when you are at the age of 65
- It has fixed premiums that won’t increase with age
- The cash and interest disbursements could be considered the income tax free
- It provides option to borrow (in case you need it) against the cash value. You can also do it later in life
However, there are several downsides that come with this policy. The first one is that the interest rate is possibly not guaranteed even though there could be a floor rate at minimum. Premiums aren’t exactly flexible, and they must be consistently paid. Moreover, it has the (potential) opportunity cost with the low-relative interest rates.
What Is IUL Insurance?
It would only be fair if we also talk about the IUL in indexed universal life insurance vs whole life ‘battle’. This kind of policy is basically new. As the name suggests, the earning potentials would be tied to the equity index. In general, the policies aren’t only more complex but they are also riskier.
This kind of policy enables the (policy) holders to allocate all or only a portion of their (net) premiums to the cash account. Of course, after they pay the insurance expenses and coverage. The account would credit interest depending on the underlying index’s performance with the 0% of cap rate and return or the participation cap (for the return). The dynamics and mechanism start to be a bit darker (and murkier) when viewing the possibility of how the construction of index exposure, and how it is built. Instead of buying the equities outright, the (insurance) company generally enters the options contracts by using a small portion of the policy premium. It would enable the company pass the upside gains without having to deal with the downside losses, but with the cost of extra counterparty risk.
Many of these insurance companies would provide the minimum rap rates that may range from 1% to 4%, and with participation rates going around 50% even though some may provide the nonguaranteed (cap) rates in between 10% and 14%. The participation rates may go in excess of around 100% for sales materials. In the event the underlying index returns around 20%, the policyholder only realizes a return of 10% to 12% with the caps in the right place. The usage of stock options would also remove the dividends from the index return calculation, which typically accounts for around the 2% to up 4% the total (market) return. Without the return, the policyholders may be able to generate lower return than benchmark indexes.
Just like everything, this one has its own perks and flaws. Before going further for indexed universal life insurance vs whole life, the benefits of the policy are:
- There is an option to borrow against the policy, in case you need it later
- The policy offers guaranteed benefits
- It is potential for the higher interest earnings
- It has flexible premium payments
However, there are also the downsides, such as:
- The expenses are generally higher
- The earnings would depend on the equity performance
- The death benefit itself may be forfeited or reduced if the premium payments lags behind the performance
- There is always a possibility for the premium to ride over period of time
- The policy uses complex and complicated derivative investments
- In the event the index fails, the returns can be low or inferior although there have been floors (quite often) to prevent the extreme losses
Which One is Better?
In terms of indexed universal life insurance vs whole life, you need to know the basic differences of the two. Whole life (insurance) policy is created to be exactly a life insurance. On the contrary, the IUL is more like a retirement income type. The funds within these policies would grow on the tax deferred basis, and they could be used to pay the premiums. Not to mention that the policy holders can also take the (tax free) distributions from the accrued (cash) value during the retirement. It can be done to help to cover any expense. This can be useful for the holders already max out the Roth IRA as well as other options. Many of these policies are being sold based on the accumulating cash value’s concept instead of the (guaranteed) death benefits.
It’s also crucial that you would put thoughts about derivatives usages by the IUL insurers. Because the call option would be inherently capped within a certain level (or expires worthless), the (IUL) policies would have their own limitations to the max returns within good years. It would also limit the possible downside up to 0% returns, especially during bad years. It is general that the insurance providers would tout the high returns for the IUL policies as taking advantage of the recency bias, in the event the equity indexes have performed well – as of late.
Some IULs would also come with the guaranteed contractual benefits, done through the riders. This can provide guaranteed benefits comparable to the general account products. But still, the policy holders of the IUL wouldn’t rely completely on the high (equity) index returns to fund the policy cash value, leading to the coverage lapse if the returns aren’t satisfying or profitable. Moreover, taking the policy loans (from the cash value) as well as paying interest would be considered risky, especially if the credited interest isn’t able to cover the loan costs.
So, in indexed universal life insurance vs whole life, there is an obvious differentiation. Whole life is basically a life insurance with fixed premiums. On the contrary, the IUL moves toward the retirement income sources, having its own investment portion. The growth should pay interest rate matching the equity index. In saving, there is no such a thing as the better and the worse option. All kinds of investments or savings are good, but you do need to consider your own saving preference and which one you like the most. After all, you are going to save up a portion of your money, so it would be crucial that you choose the one that you are comfortable with.
Which Is For You?
In deciding about indexed universal life insurance vs whole life, it also depends on your personal preferences. The policy may be suitable for those who are in favor of predictability (over time). This insurance offers fixed premiums and death benefit guarantees. It would be just perfect for those who like routine and predictability. In the meanwhile, the IUL would be the perfect option for those who want to have a death benefits as well as investing money. If you want to save up money, but you want something that isn’t as traditional as borrowing from the bank, then having the IUL policy would be the best option. Financial and insurance experts state that this kind of life insurance would be just the one you need if you want to have a lifelong life insurance; plus cash account at the same time.
As you can see, each option has its own advantage and downsides. Make sure that you really understand each of them completely (and carefully), so you can make a better decision about indexed universal life insurance vs whole life.