IUL vs. Whole Life: An Overview
Whole life insurance and indexed universal life insurance, or IUL, are two types of permanent life insurance policies without an expiration date. Both include cash value, which is money you can take out while you're alive. Whole life is a more predictable option as the premiums stay the same and your cash value grows by a guaranteed minimum amount. With an IUL policy, you can change your premium while your cash value growth depends on a market index.
Key Takeaways
- Whole life insurance and index universal life insurance, or IUL, are varieties of permanent life insurance.
- Whole life policies guarantee benefits with fixed premiums and known minimum growth.
- Indexed universal life (IUL) policies have flexible payments with cash accumulation pegged to the performance of an equity index.
- Whole life insurance is safer and simpler. IUL has higher upside potential, but is riskier and takes more work to manage.
Whole Life Insurance
Whole life insurance policies generally are considered the safest option for those looking to provide for their family after death. These policies include fixed premiums that do not change, a guaranteed death benefit, and a guaranteed but low cash value growth rate. If you'd like one of these policies, it's especially important to research providers to ensure they're among the best whole insurance companies currently operating.
The Pros
- Guaranteed death benefits
- Fixed premiums that don’t increase with age
- Option to pay up face value in 10 years, 20 years, or at age 65
- Option to borrow against cash value if needed later in life
The Cons
- Potential opportunity cost with relatively low interest rates
- Premiums aren’t flexible and must be paid consistently
- High initial cost for premiums
Indexed Universal Life Insurance
Indexed universal life insurance policies are relatively new. These policies are riskier and more complex. You can adjust your premium up and down each year, but you must pay enough to cover the insurance cost, which increases over time.
Indexed universal life insurance policies give policyholders the option to allocate all or a portion of their net premiums (after paying for the insurance coverage and expenses) to a cash account. This account credits interest based on the performance of an underlying equity index such as the S&P 500 or the Nasdaq 100.
While having your investments tied to a stock index is riskier than having a fixed rate of growth, indexed universal life insurance policies include a minimum guaranteed interest rate. Even if the market index loses value in a year, your policy cash value grows by some amount. In exchange, these policies also set a limit, called a cap, on your upside. For example, an IUL may cap your upside to 9% a year, even if the actual market index grows by more.
The Pros
- Flexible premium payments
- Potential for higher interest earnings
- Option to borrow against the policy or withdraw cash value later in life
The Cons
- Earnings depend on equity performance
- If the index falls, returns can be worse than with a whole life policy, although there are often floors to limit losses
- Potential for premiums to rise over time
- Higher expenses
- The death benefit may be reduced or forfeited if premium payments lag behind performance.
Deciding Between the Two
Whole Life Insurance—Who It's Right For
Whole life insurance is designed to be life insurance first and foremost, as opposed to an investment vehicle. You pay a fixed premium for a guaranteed future death benefit. If the whole life policy has cash value, it grows by a steady but relatively small rate.
Whole life insurance can make more sense if you primarily want life insurance protection and don't want to spend time planning your premiums and investments. Whole life could also be suitable if you want a safe reserve of cash value to use during your lifetime.
Index Universal Life Insurance—Who It's Right For
In contrast, indexed universal life insurance policies are more like retirement-income vehicles.In fact, many policies are sold based on the concept of accumulating cash value rather than a guaranteed death benefit, thanks to the higher potential returns from the market index. Since cash value in a life insurance policy grows on a tax-deferred basis, an IUL can be a useful option if you've already maxed out your Roth IRA and other retirement accounts.
However, IULs involve more risk and require more planning. For example, high returns in some years can lead to policyholders neglecting to fund the cash value of the policy. This could lead to much higher premium costs or even a lapse in coverage later in life if returns aren’t quite as good.
Taking out the policy cash value could also lead to the policy lapsing later in life if the credited interest doesn't cover the rising insurance costs. Therefore, an IUL makes more sense if having another way to build wealth is more important to you than the guarantee of a life insurance death benefit.
What Are the Main Differences Between IUL and Whole Life?
Whole life is simply life insurance—no bells or whistles—with a fixed premium and a steady, low cash value growth rate. In contrast, indexed universal life insurance policies are more like retirement-income vehicles with an investment portion whose growth will pay an interest rate based on an equity index.
Are IUL Policies Risky?
That depends on your definition of and tolerance for risk. If you want a plain vanilla policy that carries no risk and no potential for a high return on investment, then whole life is for you. IUL policies are riskier which is why they offer a potential payoff.
Which Is the Safest Option?
Whole life is considered the safest option for those looking to provide for their family after death. Remember that in addition to paying a death benefit, whole life insurance also containsa savings component in which cash value may accumulateon a tax-advantaged basis. These policies may be known as “traditional” life insurance.
The Bottom Line
Individuals shopping for permanent life insurance that offers a cash component as well as insurance coverage have several different options. Whole life is generally the safest route for those looking for something predictable and reliable, while IUL policies provide an interesting retirement-planning vehicle with greater upside potential and tax advantages.
Notes
Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circ*mstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal. Investors should consider engaging a financial professional to determine a suitable retirement savings, tax, and investment strategy.
