Indexed universal life insurance (IUL): Risks, costs, and how it works

Indexed universal life insurance (IUL) is a complex insurance product that combines life coverage with a cash value component. The cash value grows based on the performance of a market index, such as the S&P 500, rather than a fixed interest rate like whole life insurance. When you purchase an IUL policy, your premium payments are typically divided into three parts: a portion goes towards the death benefit, another part contributes to the cash value, and the remaining portion covers policy fees and charges.

One of the primary differences between IUL and other permanent life insurance policies is the way the cash value earns interest. With whole life insurance, the interest is fixed, but with IUL, it's tied to the performance of a stock market index. If the index does well, your cash value can earn more interest. Conversely, if the index performs poorly, your credited interest may be lower or even 0%, depending on the terms of your policy.

There are several features that can impact how much interest your IUL policy earns, including caps, floors, and participation rates. A cap sets the maximum interest rate your policy can earn during a crediting period, while a floor establishes the minimum interest rate. The participation rate determines how much of the index's gain is credited to your policy.

These features can lead to significant variations in the performance of different IUL policies, making it essential to carefully review the specifics of any policy you're considering.