Warren Buffett once famously said:
“Rule number 1: Never lose money.
Rule number 2: Never forget rule number 1.”
An Indexed Universal Life (IUL) policy is permanent life insurance coverage that capitalizes on that idea. An IUL has a death benefit and builds cash value. The cash value is indexed to a stock market index—most popularly, although not exclusively, the S&P 500— over a specific time period, usually 1 year, but some policies offer 2 or more period years.
If the stock market index goes up over the time period, the policy cash value interest rate captures a percentage of that growth. An example to illustrate the point:
IUL POLICY | DETAILS |
IUL index: | S&P 500 index |
Current cash value: | $10,000 |
Interest cap: | 10% |
Interest floor: | 0% |
Time period: | 1 year |
Let’s assume from one year to the next the S&P 500 index experienced 20% growth. Your IUL cash value would participate in some of this growth. Since your IUL has a maximum interest cap of 10%, the cash value in your policy would be credited with $1,000 ($10,000 x 10%). You now have $11,000 in cash value in your policy.
Now let’s assume the following year the S&P 500 index experienced a decline of 20%. Due to your interest floor of 0%, your credited cash value interest rate will never be less than 0%. In this year, you will not gain, but you do not lose. The cash value in your policy remains at $11,000. So consistent with the Buffet rule, you never lose money due to market declines.
Perhaps we should mention here that the IUL was created by Transamerica in 1997 and not Warren Buffett, but an IUL certainly captures the essence of his rule.
Using our hypothetical example, had your money actually been invested in the stock market in a S&P 500 index fund, the first year you would have earned $2,000 or 20% for a total of $12,000 in stock value. The 2nd year when the S&P 500 declined by 20%, your stock value would have declined to $9,600.
An IUL is another way to manage and grow dollars for retirement, particularly if you’ve met your employer’s match funding or the maximum annual contribution to your 401(k) or IRA. An IUL can be viewed as a way to manage risk with your dollars and not as a substitution for investing in the stock market.
Additionally, the cash value in an IUL grows tax deferred, and the cash accumulated can be borrowed tax free. In essence, you can become your own bank while maintaining earnings growth potential on your cash value.
Unlike a 401(k) or IRA there are:
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