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While not for everyone, indexed universal life insurance policies are a viable option for people looking for the security of a fixed universal life policy and the interest-earning potential of a variable policy.
What’s good about IUL’s:
- Low price: The policyholder bears the risk, so the premiums are low.
- Cash value accumulation: Amounts credited to the cash value grow tax-deferred. The cash value can pay the insurance premiums, allowing the policyholder to reduce or stop making out-of-pocket premiums payments.
- Flexibility: The policyholder controls the amount risked in indexed accounts vs. a fixed account, and the death benefit amounts can be adjusted as needed. Most IUL policies offer a host of optional riders, from death benefit guarantees to no-lapse guarantees.
- Death benefit: This benefit is permanent, is not subject to income or death taxes, and is not required to go through probate.
- Less risky: The policy is not directly invested in the stock market, thus reducing risk.
- Easier distribution: The cash value in IUL policies can be accessed at any time without penalty, regardless of a person’s age.
- Unlimited contribution: IUL policies have no limitations on annual contributions.
What’s bad about IUL’s:
- Caps on accumulation percentages: Insurance companies sometimes set a maximum participation rate that is less than 100%.
- Better for larger face amounts: Smaller face values don’t offer much advantage over regular universal life policies.
- Based on an equity index: If the index goes down, no interest is credited to the cash value. (Some policies offer a low guaranteed rate over a longer period). Investment vehicles use market indexes as a benchmark for performance. Their goal is normally to outperform the index. With the IUL, the goal is to profit from upward movements in the index.
What if you could get the flexibility of adjustable life insurance premiums and face value and an opportunity to increase cash value—would you go for it? What if you could get this without the inherent downside risk of investing in the equities market? All of this is possible with an indexed universal life insurance policy. These policies aren’t for everyone, so read on to find out if this combination of flexibility and investment growth is a good fit for you.
Indexed universal life (IUL) allows the owner to allocate cash value amounts to either a fixed account or an equity index account. Policies offer a variety of well-known indexes such as the S&P 500 or the Nasdaq 100. IUL policies are more volatile than fixed ULs, but less risky than variable universal life policies because no money is actually invested in equity positions.
The value of the selected index is recorded at the beginning of the month and compared to the value at the end of the month. If the index increases during the month, the interest is added to the cash value. The index gains are credited back to the policy either on a monthly or annual basis. For example, if the index gained 6% from the beginning of June to the end of June, the 6% is multiplied by the cash value. The resulting interest is added to the cash value. Some policies calculate the index gains as the sum of the changes for the period. Other policies take an average of the daily gains for a month. If the index goes down instead of up, no interest is credited to the cash account.
The gains from the index are credited to the policy based on a percentage rate, referred to as the participation rate. The rate is set by the insurance company. It can be anywhere from 25% to more than 100%. For example, if the gain is 6%, the participation rate is 50% and the current cash value total is $10,000, $300 is added to the cash value (6% x 50% x $10,000 = $300).