Why Banks Buy Indexed Life Insurance For Employees

Indexed universal life insurance (IUL) is a type of permanent life insurance that offers a cash value component and a death benefit. It is designed to provide lifelong coverage and build cash value over time. Unlike other universal life policies, IUL allows for cash value growth through an equity index account, such as the S&P 500 or NASDAQ, rather than solely through non-equity earned rates. This means that the cash value in an IUL policy can increase based on the performance of a specific stock market index.

IUL policies offer flexibility, as policyholders can adjust their premiums and death benefits. Additionally, the cash value can be used to lower or fully pay for premiums without reducing the death benefit. However, IUL policies are generally more expensive than other types of life insurance due to higher premium costs and potential fees.

While IUL provides permanent coverage, it is important to note that the policy may be canceled if the policyholder stops paying premiums. Furthermore, there are potential limits on annual returns, and the premium amounts and market returns are not guaranteed.

In the context of a bank purchasing indexed life insurance on an employee, it is essential to consider the specific circumstances and regulations surrounding such arrangements.

Indexed universal life insurance (IUL) vs. term life insurance

Banks can purchase life insurance on their employees, and indexed universal life insurance (IUL) is one type of policy they can consider. IUL is a type of permanent life insurance that provides a cash value component and a death benefit. The cash value in a policyholder's account can earn interest by tracking a stock market index, such as the S&P 500 or Nasdaq-100. IUL policies also offer fixed-rate accounts, where policyholders can allocate a portion of their cash value.

IUL policies have adjustable premiums, and policyholders may be able to adjust their death benefit. The total cash value is credited with interest based on increases in an equity index, although the money is not directly invested in the stock market. Policyholders can borrow against the cash value accumulated in the policy, but any outstanding loans will be deducted from the death benefit if unpaid.

IUL policies offer permanent coverage, flexible premiums, and a death benefit that is not subject to income or death taxes. They also provide the opportunity for cash value accumulation and investment flexibility. However, IUL policies may have higher fees and premiums compared to other types of life insurance, and there may be limits on the maximum amount that can be earned.

Term life insurance, on the other hand, offers a fixed benefit if the policyholder dies within a set period, usually between 10 and 30 years. It is one of the most affordable and simplest types of life insurance, but it does not offer cash value accumulation. Term life insurance policies have fixed premiums and benefits, making them more straightforward than IUL policies.

In summary, IUL policies offer more flexibility and the potential for higher returns, but they also come with higher fees and premiums. Term life insurance is more affordable and straightforward, but it does not offer cash value accumulation or flexible benefits. The choice between IUL and term life insurance depends on the individual's needs and financial goals.

IUL vs. whole life insurance

Banks can purchase indexed life insurance on an employee, and this is known as corporate-owned life insurance. This is usually done as a form of insurance funding for employees' post-retirement benefits.

Now, here is a comparison of IUL vs. whole life insurance:

Indexed universal life (IUL) insurance and whole life insurance are both permanent life insurance policies that offer lifelong coverage and a cash value component. However, there are several key differences between the two types of policies.

Cash Value Growth

The main difference between IUL and whole life insurance lies in how the cash value grows. With IUL insurance, the cash value is tied to the performance of a stock market index, such as the S&P 500 or the Nasdaq-100. This means that the cash value can fluctuate based on the performance of the index, potentially leading to higher returns but also introducing more risk. On the other hand, whole life insurance offers a fixed interest rate on the cash value, resulting in more predictable and stable growth.

Premium Flexibility

IUL insurance offers flexible premiums, allowing policyholders to adjust their payments up or down as needed. In contrast, whole life insurance premiums are fixed and cannot be changed. This fixed premium structure provides stability and predictability but may be less suitable for those who want the option to adjust their payments.

Investment Risk

IUL insurance is considered riskier than whole life insurance due to its connection to the stock market. While IUL policies typically have a minimum guaranteed interest rate to protect against losses, they also often have caps on the maximum returns. Whole life insurance, on the other hand, offers guaranteed returns and a fixed growth rate, making it a safer and more conservative option.

Complexity and Management

IUL insurance is generally more complex than whole life insurance due to its variable nature. Policyholders need to actively monitor and manage their IUL policies, especially during periods of low returns, to ensure the policy remains in force. Whole life insurance, on the other hand, is simpler and more straightforward, providing guaranteed benefits with fixed premiums.

Suitability

IUL insurance may be more suitable for individuals seeking higher upside potential and tax advantages as part of their retirement planning. It offers the opportunity to accumulate cash value through market index performance. On the other hand, whole life insurance is designed for those who prioritize stability and guaranteed benefits. It is ideal for individuals who want straightforward life insurance protection without the added complexity of investment risk.

In summary, the choice between IUL and whole life insurance depends on an individual's risk tolerance, financial goals, and preferences. IUL insurance offers flexibility, investment potential, and tax advantages but comes with higher risk and complexity. Whole life insurance provides stability, guaranteed benefits, and a fixed premium structure but may not offer the same level of upside potential.

IUL vs. variable life insurance

Banks can purchase indexed life insurance on an employee, and this is known as endorsement split-dollar insurance. In this arrangement, the bank owns the policy and controls all rights of ownership. The bank provides the employee with an endorsement of the portion of the death benefit specified in the plan agreement. The employee may designate a beneficiary for the designated portion of the death benefit.

Now, indexed universal life insurance (IUL) and variable life insurance are two types of permanent life insurance policies. IUL insurance policies can help build wealth while providing a death benefit for loved ones. A portion of the policyholder's premium payments go toward annual renewable term life insurance, while the remainder is added to the cash value of the policy after fees are deducted. The cash value is credited with interest based on increases in an equity index, and this interest is either calculated monthly or annually. IUL insurance is considered less risky than variable life insurance because cash is not directly invested in the stock market.

IUL insurance offers permanent coverage, higher return potential, greater flexibility, and tax-free capital gains. However, there are also drawbacks, such as possible limits on annual returns and unpredictable returns. The returns on IUL policies are also capped, and there may be higher fees involved.

On the other hand, variable life insurance offers even more flexibility than IUL insurance, making it a more complex option. The cash value of a variable policy may depend on the performance of specific stocks or securities, and premiums can also change over time. Due to this direct investment in the market, variable life insurance is considered riskier than other types of life insurance policies.

Pros and cons of IUL insurance

Pros of IUL Insurance

IUL insurance offers several advantages over other types of life insurance. Here are some of the key pros:

• Potential for Higher Returns: IUL insurance offers the potential for higher returns compared to other types of life insurance, such as traditional universal or whole life insurance policies. The cash value of an IUL policy can increase over time, providing greater upside potential.
• Tax-Free Gains: IUL insurance provides tax advantages, including tax-free gains on capital accumulation. The cash value accumulates tax-deferred, and withdrawals up to the amount of premiums paid are generally tax-free.
• No Impact on Social Security Benefits: IUL insurance does not affect Social Security benefits. The cash value accumulation and loan amounts borrowed from the policy do not count towards earnings thresholds, allowing individuals to supplement their Social Security income without reducing their benefit amount.
• Flexibility: IUL insurance offers flexibility in terms of premium payments and death benefit adjustments. Policyholders can pay premiums according to their financial situation and adjust the death benefit as their financial needs change.
• Lifelong Coverage: IUL insurance provides permanent coverage as long as premiums are paid. This ensures that beneficiaries receive a payout upon the policyholder's death.
• Additional Benefits: IUL policies often include additional protection benefits, such as coverage for chronic illness or lawsuits. Policyholders can also choose from a variety of riders to customise the policy to their specific needs.

Cons of IUL Insurance

While IUL insurance offers several benefits, there are also some drawbacks to consider:

• Limits on Returns: IUL insurance policies typically have caps on returns, which can limit the potential for higher returns. The insurance company may set maximum participation rates, and returns on equity indexes may be capped during favourable years.
• No Guarantees on Returns: IUL insurance does not guarantee higher returns. Returns can be lower than other products, depending on market performance. Policyholders must accept the risk of potentially lower returns for the chance of higher gains.
• Complexity: IUL insurance is considered one of the most complex life insurance products. Understanding how IUL works, managing the policy, and making adjustments can be demanding for some individuals.
• Higher Fees: IUL insurance policies often come with higher fees and costs compared to other types of life insurance. These fees, including premium expense charges, administrative expenses, and commissions, can eat into the cash value and reduce the overall return on investment.
• Risk of Lapse: If premium payments are not maintained, there is a risk of the IUL policy lapsing. This could result in losing the death benefit and the money invested in the policy.

How IUL insurance works

Indexed universal life (IUL) insurance is a type of permanent life insurance that provides a cash value component and a death benefit. The cash value in a policyholder's account can earn interest by tracking a stock market index chosen by the insurer, such as the Nasdaq-100 or the Standard & Poor's 500.

IUL insurance policies are more volatile than fixed universal life policies but are less risky than variable universal life insurance policies because they do not invest directly in equity positions. The interest rate derived from the equity index account can fluctuate, but the policy offers an interest rate guarantee, which limits losses. It may also cap gains, typically around 8-12%.

IUL insurance policies have adjustable premiums, and the death benefit may also be flexible. Policyholders can decide how much cash value to assign to an equity-indexed account and a fixed-rate account, if available. The value of the selected index is recorded at the beginning of the month and compared with the value at the end of the month. If the index increases during this period, interest is added to the cash value.

IUL insurance offers permanent, lifelong coverage when premiums are kept up to date. The accumulated cash value can be used to lower or cover premiums without reducing the death benefit. Some policies may allow the policyholder to select multiple indexes.

IUL insurance policies are best suited to those with a large upfront investment who are seeking options for a tax-free retirement. They offer higher returns than other life insurance policies, greater flexibility, and tax-free capital gains. However, there are also more risks and costs associated with IUL insurance, and it is important to understand these fully before purchasing a policy.

Frequently asked questions