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Back in the 90s, there was a popular saying. If someone ticked you off, you would put up your hand and say, “talk to the hand.”
Arnold can showcase for us. Hit it, Arnold:
Sometimes, you need to say this to pushy insurance agents who don’t truly know your background and needs. They are trying to force feed you an insurance product which you may not understand completely. Frankly, there usually is more benefit to them than with you. We have seen this with indexed universal life insurance based on the number of calls or questions we have received.
We recently wrote about indexed universal life insurance as an introductory article for our fellow readers. Now we go into detail on some of the cobwebs with this product. In this article, we discuss the disadvantages of indexed universal life insurance.
Beware Of The “Hook”
Here is how the hook develops…
You are at a meeting or maybe you are at a member event with your chamber of commerce. Gosh, maybe you are standing in line at the supermarket! You end up speaking to a local insurance agent and get to talking about the stock market. Invariably, the discussion leads to why you (both) hope there isn’t a market correction because you don’t want to see your retirement portfolio take a hit as it did in 2008-2009.
This is the insurance agent’s runway for the next question. “Well, (insert your name). How would you feel if you could have upside market potential without any downside loss risk?”
Of course, you want that. Who doesn’t? “Yes, that does sound good,” you say.
Then, a follow up. “When is a good time to meet..” The agent then asks about your availability.
Problem With The “Hook”
We have a problem with the hook. This statement implies that you will have 100% upside, investment in the market, or zero risk of loss. We know this because we asked those people who bought an indexed universal life insurance policy what was the driving factor on their purchase. It was one of the above three.
Look, we don’t have a problem with agents who sell indexed universal life insurance. We provide it, too…in the right situations. There are some advantages, but there are many disadvantages of indexed universal life insurance. Let’s talk about those disadvantages in detail now.
The Disadvantages of Indexed Universal Life Insurance
Here is one of the major disadvantages of indexed universal life insurance…it still is life insurance!!!! And, it is a type of universal life insurance as well.
Surely, the agent ultimately tells you it is life insurance (at your meeting, of course). Before the agent does so, however, you are probably thinking this is some type of investment, right?
Universal life insurance is a hard one for the everyday person to understand. All of its components are unbundled, meaning, in the simplest terms, you can adjust your premiums. You can pay a lower amount if you want. You can even skip a payment if you want to, provided there is sufficient cash value in the policy.
This flexibility is also a big problem with universal life insurance. If its costs become too great, and there is insufficient cash value in the policy, the carrier will require you to increase your premium – sometimes substantially – to keep the policy in force. This is clear from the diagram below:
This brings us to our first tenet on purchasing indexed universal life insurance – purchase it for the life insurance component, not for the cash value. Note: there are some people who might benefit from this type of policy, and we will get to those people in a minute.
The disadvantages of indexed universal life insurance abound. Here are some more…
More Disadvantages Of Indexed Universal Life Insurance
Indexed universal life insurance (and universal life insurance, for that matter) has a lot of fees. Just look at the above. There are fees for:
- premium expenses
- cost of insurance
- administrative expenses
- surrender charges
The life insurance agent will rebuke and say professional wealth and money management contain many fees. We say, maybe, but probably not. As we mentioned here, the average family doesn’t need to spend a lot on professional money management. This real life example has a 6% premium charge! That means $94 of a $100 premium is invested in cash value. We don’t see that level of fees with wealth management. In fact, we rarely do.
This brings us to the second tenet on purchasing indexed universal life insurance – purchase it for the life insurance component.
Additional Disadvantages of Indexed Universal Life Insurance
The following disadvantages are rolled into one, because they all deal with returns.
Unlike the cash value returns in a traditional universal life policy, the cash value returns in an indexed universal life insurance policy are pegged to a stock market index. Common indices are the S&P 500, the DOW, or the NASDAQ.
You won’t fully participate in the index returns, though. Wait, you thought you would? No, you don’t. You may participate in 70% to 80% of the index performance. Maybe less depending on the limitations. The carrier offers performance limits such as caps, spreads, and participation rates. You can find more about them here.
They provide these limits because of the downside risk element. It is true; indexed universal life insurance does provide no downside risk. In order to provide zero downside loss, the carrier has to limit the upside.
But, your cash value is subject to loss IF you withdraw the money during the surrender charge period. These surrender charges lock your money in for as long as 15 years in some cases!!
Recently, many carriers have improved their caps, spreads, and participation rates. But, don’t think the good times can roll forever. Carriers stipulate they can change these rates as market conditions change.
Moreover, the long-term cash value return for these policies is similar to that of bonds. Yes, you go through all of this for a bond return. “Why not invest in low-cost bond fund, then?” you ask. You read our mind.
Disadvantages Of Indexed Universal Life Insurance Continued…
And, if you are in questionable health, your cost of insurance is much greater. This greater increase drags your cash value return down. Golly, remember that this is life insurance!!!
Finally, be mindful of looking at carrier-provided illustrations. Nearly all the ones we have seen start the illustration in the year 2007/2008, when the market tanked. These illustrations make it appear that indexed universal life insurance is a great, long-term solution. However, if you purchased an indexed universal life insurance policy in 2009/2010, your returns are surely behind that of the market (at the time of this writing).
This all brings us to the third and final tenet on purchasing indexed universal life insurance. Purchase it for the life insurance component!!! (Do you see a trend?)
The Real Reason To Purchase An Indexed Universal Life Insurance Policy
You probably think we are totally against indexed universal life insurance? We are not. We simply believe indexed universal life insurance should be purchased for its real reason: life insurance. (Duh???)
In our opinion, if you are focusing on the cash value potential only, you may be disappointed. We have addressed those disappointments by describing the disadvantages of indexed universal life insurance.
Most people, like you and me, simply need term life insurance and then invest any term life savings into your retirement savings account.
(Did you know we have the lowest priced term life insurance, guaranteed for your situation? Click here to see how much you can save.)
However, there is a small subset of people who might need an indexed universal life insurance policy. Read on to find out who.
People Who Might Need An Indexed Universal Life Insurance Policy
While indexed universal life insurance is not for everyone, there is a small subset of people who could utilize it. Yes, and they include people with a life insurance need!
Indexed universal life insurance may be useful for:
- the affluent or very wealthy. These people have a life insurance need. Moreover, they could use the cash value as tax-free income. You see, the affluent has the money to dump in large amounts of premiums to take full advantage of the insurance. They can mitigate any expense drag from these large premium purchases.
- people who have contributed the maximum to their retirement accounts. They are looking for alternative ways to save. The cash value in an indexed universal life insurance policy is one way to save.
For everyone else, stick with term life insurance and investing the savings into your retirement accounts.
We feel that the disadvantages of indexed universal life insurance outweigh any benefits for the typical indiviudal and family. Just like traditional universal life insurance, indexed universal life insurance requires vigilance. Moreover, if the stock market or index does not rise, or has consistent, mediocre returns, the expense drag might wipe out any cash value within the policy. If you are going to purchase indexed univeral life insurance, purchase it for what it is: life insurance.
If you feel that an indexed universal life insurance policy is right for you, or you want to get out of one, contact us. We have helped many individuals and families match the right life insurance to their specific situation.