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Basics of Indexed Universal Life Insurance (IUL)

Indexed universal life insurance (IUL) is a unique financial product. If you choose one of the top IUL policies available today, you get life insurance, and possibly a valuable disability benefit. But if properly structured, you also get a cash accumulation engine that can outperform most competing methods, especially if you throw in leverage made possible by participating loans (also known as “indexed loans”, "alternate loans", or “variable loans”). This makes IUL a good alternative to a 529 plan or Coverdell ESA plan for college, and even a good alternative to your 401(k) or other qualified plan, especially when one takes into account the catch-up provisions unique to IUL. If you make use of the Early Cash Value Rider, IUL can even be an alternative to leaving large sums of money in banks.

There are several things that set IUL apart: favorable income tax treatment, the certainty of no investment loss, and the high probability of being able to place money in a vehicle that may grow at a 9% to 12% rate long term – possibly never reduced by income taxes! This cash value serves as collateral for loans that (when using a top carrier) can never be charged more than 6% interest (Some insurance companies offer participating loans at a lower current rate - say 4.7% - with a higher rate cap - say, 7.5%.)   Leverage may propel the growth rate even higher, so long as you are careful not to use too much of a good thing. For help in ongoing analysis and monitoring this balancing act, we recommend you consult our affiliated company, Plan Trackers, Inc.

Furthermore, so long as this cash value collateral exceeds the loan and its accrued interest, the loan never needs to be paid off during the lifetime of the insured. If, as expected, the collateral grows faster than the loan, the loan is paid off at the death of the insured. This loan pay-off would be made from life insurance death proceeds, which in nearly all cases are income tax free.

Indexed universal life insurance, also known as equity indexed universal life insurance, has all of the elements of traditional universal life insurance. The difference lies in the way a portion of premium deposits is invested.

Part of each premium, while not directly invested in equities, will pattern any credited gain after the performance of a specific equity index or multiple equity indices. Most of the indices used are stock indexes for the United States, Asia, and Europe. Through the use of options (puts and calls), the insurance company provides caps and floors (or uncapped indices with a "spread", where you miss the first 5% or so of gains, but are credited with everything above that). Policies generate one monthly “bucket” of funds at a time. It should be noted that nearly all index strategies involving caps will carry a 100% participation rate. Most uncapped strategies also carry participation rates of 100%, but omit gains from zero up to the spread figure just mentioned. Most index strategies have a minimum of a zero floor, and thus no possibility of investment loss (apart from multiplier bonus strategies, having extra expense charges).

Some newer IUL products offer "multiplier bonus crediting". These products include higher expense charges, which have the effect of turning a "zero floor" into a floor of as low as minus 8%. Although performance of these products introduces significantly more volatility, in years where there is a positive credit, that credit has the potential to be double or triple. A recent uncapped credit of 21% would have been around 58% less the 7.5% extra charge - a net credit of 51%! Again, for assessing the feasibility of using one of these products, we recommend you consult Plan Trackers, Inc.

Each bucket of invest-able funds mimics the performance of one or more of these indices. Actual return to the policyholder will depend not only upon the performance of one or more of the given indices, but also upon the cap, floor, spread, and participation rate that is in place for each given segment (bucket) created within the policy.

Choosing the right insurance company is no less important with indexed universal life than with other forms of life insurance. Merely tying performance to an outside equity index does not, by itself, determine overall success. It is still important to see how much of a given premium is siphoned off to pay for mortality (cost of insurance), and operating expenses. The investment success of the company’s General Account will play a large role in determining the cap (or participation rate) that applies to any index.

Need more from a tax authority? See this video by Ed Slott, CPA, - one of the nation's most respected retirement experts.

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The Duplifund Group
The Duplifund Group