Term Life Or Indexed Universal Life Insurance?
Should you buy a term life policy or an indexed universal life insurance policy? Some years back, a guy named A. L. Williams attracted a lot of attention and made a lot of money by encouraging people to cash in the value of their whole life insurance policies, buy term life, then invest the rest. The entire campaign was based on two ideas, that term life is less expensive than whole life and you can get a better return on your investments than the insurance companies were paying. I wasn’t an agent at that time, so I can’t say if it was true or not. But I don’t believe it’s true now.
Term life is considered “pure insurance” because it only pays for a death benefit if somebody dies. If two healthy people who are the same age each buy the same face value of insurance, the one who buys a term life policy will pay a lower premium for their coverage than the one that buys an indexed universal life insurance policy – for the first year!
Term life is considered temporary insurance. It must be renewed on a regular basis, either yearly or at the end of a fixed period of time like 5-years, 10-years, etc. No matter what the renewal period, the premium will change for the next period and it will always go up. At the end of the period of coverage, the buyer must renew or the coverage is done. There is nothing left. So, if you buy term life for 20 or 30 years and don’t die, then you’re out the cost of the premiums.
But an indexed universal life insurance policy is different. The premium is larger to allow the build-up of cash value and the policy is considered permanent insurance because it’s designed to cover you until death or age 100, whichever comes first. The premium always stays the same unless you want to add more to the cash value. The longer the policy is in force, the larger the cash value becomes. If you ever need to use some of the money you’ve paid, in the case of an emergency for example, you can borrow against the cash value. If you live to be 100 and have not died, then the entire cash value (less any outstanding loans), will be paid back to you at that time, offsetting virtually all of the premiums you paid. If you choose, you can have the cash value paid out during retirement, to supplement your other income, while maintaining the death benefit to age 100. So your long term cost is now zero. The longer you own the policy, the less expensive the universal life policy is when compared to a term life policy.
The key is the cash value and there have been some big changes in the methods used for building this value. The most important one, in my opinion, is the use of indexes. In 2011, most indexed universal life insurance policies are tied to the value of the S&P 500 Index. That means, when the S&P 500 goes up, the value of the indexed life policy goes up (to a cap). But when the S&P 500 goes down, the value of the indexed life policy stays the same (it has a floor). This allows the owner of an indexed universal life policy to share in the growth of the stock market without being exposed to the volatility and risk. During the “lost decade” of 2000 – 2010, when the S&P 500 stayed essentially flat for 10 years, the holders of many indexed accounts actually enjoyed average growth of 9% per year. In addition, the cash value compounds free of income taxes, which promotes tremendous growth over extended periods. These features make an indexed universal life insurance policy very important for many people, especially those in their 20’s and 30’s, who have a lot of time to build a retirement nest egg. When comparing these policies to other retirement vehicles, there is one other thing to keep in mind. Not only do you get a good rate of return and safety, you can access the funds in retirement free of income taxes, thanks to zero-cost policy loans.
So, should you buy a term life policy or an indexed universal life insurance policy? The question is a little more complicated than I’ve implied in this article but, for most people, the indexed universal life policy will be cheaper in the long run, and will produce a better rate of return than most people can get in the market by themselves.