One of the insurance products receiving some interest in recent years has been the universal index life insurance policy.
These life insurance policies are permanent life insurance policies, build cash value over time, and provide the ability to take advantage of stock market gains.
While the universal index life insurance policy can be a way to aggressively grow your cash value in a life insurance policy over time, it’s important to be aware that there are drawbacks to these types of policies as well.
How Universal Index Life Insurance Works
As with most life insurance policies, your premiums go to the insurance company, which then invests the money in bonds, stocks, funds or other investments. The insurance company makes money, hoping to make enough from premiums and investments that it can afford to pay out benefits when the insured’s life ends.
With a universal index policy, part of your premium is invested in a fund that is connected to a particular index. (Many policies are indexed to the S&P 500.) When that index does well, your cash value builds faster, and you earn more money for that year, to go into your cash value fund. If the index doesn’t do well, your cash accumulates much slower.
Many policies allow for a flexible premium, and you can choose to add more in order to help you build up your cash fund. Most universal index life insurance policies come with a guarantee that you will be credited a certain amount each year — regardless of how well the index does. This might be a very low number, such as 1% or 2% (or even a guarantee that you just won’t lose money), but it’s still an assurance that you won’t lose cash value.
Additionally, it its worth noting that most of these types of life insurance policies also have caps. This means that you won’t end up growing your cash value by as much as you would like if the index does really well.
Pros and Cons of Universal Index Life Insurance Policies
One of the biggest advantages of a universal index life insurance policy is the potential for growth, while you receive protection from volatile markets. Your cash value, depending on the state you are in, might also come creditor protection. Plus, it is usually possible to withdraw money from your cash fund without running into the same penalties and restrictions that come when you withdraw early from a tax-advantaged retirement account.
On the downside, though, is that most of these policies come with fairly high fees. The commissions are often front-loaded, so it can take years before your cash fund sees significant growth. Later in life, you might not have enough value in your cash fund to keep the policy in force, and your premiums might go up if you want to keep the policy current.
And, of course, your gains are limited by the process used by the life insurance company to figure out how much you end up with from stock market increases. In some cases, you might be better off just investing in an index fund on your own, without doing it through an insurance policy.
Overall, I still can see a place where these type policies can make sense. Currently, I can no longer participate in a Roth IRA, so I’ve been looking for another potential option to defer some money. An index universal life policy just might be the ticket. I’ll have a follow up post that shows what I bought and how much I’m paying.