One of the most valuable benefits of Indexed Universal Life (IUL) insurance is how it builds cash value over time—without exposing your money to stock market losses.
But how does that growth actually happen?
Let’s break it down in simple, clear terms.
How IUL Indexing Actually Works
When you make a premium payment, the insurance company first deducts internal policy costs such as the cost of insurance, administrative fees, and other charges. The remaining amount is allocated to your cash value account.
That’s why policy design is so important. The lower the expenses, the more money stays in your policy and has the potential to grow.
Your cash value is essentially a savings bucket within the policy.
It grows based on interest credited by the insurance company—either at a fixed rate or based on how a market index performs.
Two Account Options for Cash Value
IUL policies usually offer two main types of accounts for growing your cash value:
1. Fixed Account
This account credits a stable, guaranteed interest rate each year. For example, if the fixed rate is 4% and your cash value is $10,000, you would earn $400 that year. It’s predictable, consistent, and low-risk.
2. Indexed Account
This is the more popular option. The interest credited to your policy is linked to the performance of a market index—most commonly the S&P 500. However, your money is not invested in the stock market. Instead, the insurance company uses indexing strategies to calculate how much interest to credit to your cash value.
Index Crediting Strategies
There are several methods the insurance company use to determine how much interest to credit based on index performance. These are called crediting strategies. Here are the most common ones:
Cap Strategy (Most Common)
This strategy limits how much you can earn in a given year.
If the index rises by 8% and your cap is 10%, you get 8%.
If the index rises by 15%, you’re capped at 10%.
If the index drops by 20%, your policy earns 0%—not negative.
Your account never loses value due to market performance, and any gains you earn are locked in permanently.
Participation Rate Strategy
With this approach, you earn a percentage of the index’s gain.
- If the index rises by 10% and your participation rate is 100%, you earn 10%.
If the participation rate is 50%, you earn 5% from the same 10% market return.
Some policies offer enhanced participation rates, like 150% or even 200%.
You’re still protected by a 0% floor in years when the index is negative.
Spread Strategy
This strategy subtracts a set percentage from the index return before crediting interest to your cash value.
If the index grows by 12% and the spread is 5%, your return is 7%.
If the index grows by 4%, and the spread is 5%, you earn 0%.
This approach doesn’t typically use a cap, so in strong market years, you may benefit more—provided the spread isn’t too high.
Important Reminders About IUL Growth
Rates Can Change
Cap rates, participation rates, and spreads are determined by the insurance company and are subject to change. They are adjusted based on market conditions and interest rate environments. Always look at current rates, not just historical ones.
Strategies Can Be Combined
Many policies let you divide your cash value among different strategies. For instance, you could put part of your money in a cap strategy and another part in a fixed account to balance growth potential with stability.
You Can Adjust Allocations
Most insurers allow you to change how your cash value is allocated once per year, usually on your policy anniversary. This gives you the flexibility to shift your strategy as market conditions or your personal goals change.
Final Thoughts
Indexed Universal Life policies offer a unique blend of opportunity and security. You can benefit from stock market-linked growth without risking loss due to market downturns.
While rates and strategies can vary by carrier and policy design, the core advantage of IUL remains: the ability to grow wealth in a protected, tax-advantaged environment.
Proper setup and ongoing management are key. When designed well, an IUL can be a powerful component of your long-term financial strategy.
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