What Is Index Universal Life Insurance?

Index universal life insurance lets you change the death benefit and premium, and has an investment component. Is it right for you?

Written by Lindsey Danis / May 11, 2022

Quick Bites

  • Index universal life insurance is valid as long as you pay your premium and also provides a way to invest your money in a fixed account or equity index account.
  • This tax-deferred policy allows you to change your death benefit and monthly premium.
  • Most policies set a floor on the rate they pay you, which means even if markets turn down, you won’t lose money.
  • Conversely, while you may not lose money in a downturn, you also may be missing out as your cash sits there doing nothing.

The life insurance options on the market can overwhelm even the savviest of us, and index universal life insurance is among the most difficult to assess.

While there are a lot of similarities to other insurance policies, index universal life insurance is different in that the investment portion of the policy tracks stock market indexes, like the S&P 500. Insurers will calculate a rate around that index, and also offer a floor so that even if markets dip, you won’t suffer losses.

But index universal life insurance isn’t for everyone. It tends to be preferred by higher income earners and is more costly than many other options. Here’s what you need to know to decide if it’s the right choice for you.

Inside this article

  1. Explaining index universal life
  2. Pros and cons
  3. Is it right for you?

What is index universal life insurance?

Index universal life insurance is a type of permanent life insurance, or one that goes on until you stop paying monthly premiums.[1] There are a number of permanent life insurance options, so let’s break down what exactly index universal life insurance means.

First of all, we have the universal life insurance portion of the policy, which is a part of the “permanent life insurance” community (traditional whole life, universal life and variable universal life comprise permanent life insurance policies).

What’s unique to universal life insurance is that premiums are not fixed and death benefits are not guaranteed.[2] We’ll dig deeper into that below.

Universal life insurance includes a “cash value” portion. That means a part of your premium is actually a type of investment.

Unique to index universal life insurance is the “index” portion of the policy. Part of your monthly premium goes into an account that earns interest based on a stock market index chosen by your insurer, such as the S&P 500 or the Nasdaq Composite.[3] Your cash value component isn’t actually invested in an index fund but it’s managed as if it were.

Index universal life insurers will then calculate an interest rate based on the performance of the chosen index.[3] That rate is often guaranteed, meaning you should get a minimum return even if the index turns lower. So even if the S&P 500 returns a loss for the year, you won’t lose money. The rate may also be capped, however, which could limit your gains, and leave your cash sitting around doing nothing for you.

Another benefit of the index universal life insurance policy is that as the cash value grows, you can draw down on it. Some people borrow from it, though with some insurers, like Allstate, you may be charged interest. Others reduce their out-of-pocket expenses by using the cash value to pay policy premiums.

The index universal life insurance policy permits for premiums that can vary—a nice bit of flexibility if you need it—within parameters set by the insurer.[4]

What to Know About Universal Life Insurance

What to Know About Universal Life Insurance

This type of permanent life insurance offers a lot of flexibility, but it comes at a price.

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Pros and cons of index universal life insurance

Now that you understand how index universal life insurance works, you’re probably wondering if it’s right for you. These pros and cons can help you decide.

Pros of index universal life insurance

People typically choose index universal life insurance for these reasons:

  • Lifelong insurance that builds cash for you: The Insurance Information Institute recommends this policy for people who want lifelong coverage plus extra cash reserves.[1]

  • Tax-deferred: Cash value growth is tax-deferred, meaning you aren’t taxed on it until you withdraw the money.

  • Adjustable premiums: Index universal life insurance policies tend to allow flexibility in the monthly premium rate, which can be useful if you need to adjust.

  • Adjustable death benefit: You can lower or increase the death benefit.

The major reason to choose this policy, according to Todd Ackerman, president of World Insurance Associates, is its flexibility.

Not only can you adjust the death benefit and policy premium, you can use the policy as an investment vehicle. If you’ve maxed out your retirement accounts, says Ackerman, you can actually pay higher premiums and the surplus will go into the cash value part of your policy, where it will earn returns based on the performance of the index and the stipulations of a given policy.

Cons of index universal life insurance

While this coverage has its perks, there are some downsides to note:

  • Cash value returns aren’t guaranteed: Index universal life insurance has the nice benefit of protecting you when indexes drop—but that also means your cash is sitting there doing nothing.

  • Higher costs and fees: These policies tend to be more expensive.[4]

  • Not the easiest type of insurance to understand: If you’ve made it this far, you already understand that index universal life insurance is a tough nut to crack. In fact, this is the kind of insurance best discussed with a financial advisor.

How Much Is Life Insurance?

How Much Is Life Insurance?

A whole host of factors determine what your premium will be for life insurance coverage.

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Is index universal life insurance right for you?

This type of life insurance is recommended for those who are willing to take a bit of risk and who value flexibility above all, according to Ackerman. People who choose this policy appreciate the option to adjust their death benefit and lower out-of-pocket payments as cash value grows. They don’t mind paying a bit more upfront for flexibility over the long run.

Since the cash value component isn’t fixed, Ackerman doesn’t recommend index universal life insurance for someone who is uncomfortable with volatility. Nor does he recommend it to those who don’t want to pay fees on principle. 

If you’re the sort of person who wants a set-it-and-forget-it policy you can put on autopay, there are simpler options better suited to your needs.  

Before you purchase index universal life insurance, Ackerman recommends asking about the policy fees and charges, and investment floor and ceiling to set expectations. And as with any life insurance, buy when you’re young and rates are lower.

Article Sources
  1. “What Are the Principal Types of Life Insurance?” III, https://www.iii.org/article/what-are-principal-types-life-insurance.
  2. “Whole Life vs. Universal Life Insurance,” New York Life, https://www.newyorklife.com/articles/whole-life-vs-universal-life-insurance.
  3. “What Is Universal Life Insurance?" Allstate, https://www.allstate.com/tr/life-insurance/universal-life-insurance.aspx.
  4. “Indexed Universal Life Insurance: A Buying Guide,” Guardian, https://www.guardianlife.com/life-insurance/indexed-universal.

About the Author

Lindsey Danis

Lindsey Danis

Lindsey Danis is a writer covering food, travel and personal finance. She's written about personal finance for Business Insider, NextAdvisor, The Penny Hoarder, and elsewhere.

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