IUL vs. Whole Life Insurance: Which Is Right for You?

When shopping for life insurance, you have many types of coverage to consider. Indexed universal life (IUL) insurance and whole life insurance are two options that have a few similarities and some key differences. By examining the benefits and drawbacks of IUL vs. whole life side by side, you can make an informed decision about which type is the best fit for your needs.

Comparing the Key Features of IUL vs. Whole Life

Comparing the features of IUL and whole life insurance point by point can help you more easily understand their similarities and differences.

Is an IUL Permanent? Is Whole Life?

IUL and whole life are both permanent types of insurance that last until you die. They differ from term life, which only covers you for a certain period known as the term.

Do IUL and Whole Life Have Cash Value?

Both IUL and whole life build up value over time but handle the cash differently.

Whole Life

Whole life insurance places a set portion of your premium payments in an account that earns interest like a traditional savings account. Some policies pay a guaranteed interest rate on the money. Others have a variable rate but promise to pay a minimum percentage.

IUL

With an IUL policy, the money in the cash account earns interest based on how a third-party index like the S&P 500 performs. Insurance companies acquire options contracts and establish cap rates, floors and participation rates.

• Cap rate is the maximum amount of interest you can earn. Often, the cap is 10% to 14%. No matter how well the index performs, you will never make more than the cap rate. For example, if the S&P 500 grows by 25%, and you have a 12% cap, you'd earn 12% interest.
• Floor rate is the minimum amount of interest you can earn, which is usually 0%. The floor helps protect you from severe loss. For example, if the S&P 500 falls by 20%, and you have a 0% floor, you wouldn't lose 20% of the value of the account. You simply wouldn't earn interest.
• Participation rate tells you how much of the index gains you receive. Most policies have a 100% participation rate. With this arrangement, you'd receive the full gains from the index up to the cap rate. For example, if the gains were 5%, you would get the full 5%. Policies with lower participation rates pay less. If the gains were 5% and your participation rate was 50%, you'd only get 2.5%.

How Do Premiums Work With IUL and Whole Life Insurance?

With both types of life insurance, you pay for coverage through premiums, but the details of the payments vary. 

Whole life insurance may offer a few premium options that you can choose from when shopping for a policy.

• Standard whole life has monthly payments that remain the same over time, making it easy for you to budget.
• Limited pay whole life allows you to stop making payments when you reach a certain age, such as 65 or 99 year old.
• Modified whole life has lower premium payments for the first years of a policy.
• Single-premium whole life lets you make just one premium payment for lifetime coverage but requires a significant initial investment, which is often $5,000 to $10,000.

Normally, the premium payment schedule remains in place for the life of the policy after you buy it. You usually can't move from one payment option to the other.

IUL gives you more premium payment flexibility. You can usually increase and decrease the amount that you pay every month, and you have some say regarding how much of the premium payment is invested.

How Do the Death Benefits Compare?

Whole life insurance pays a guaranteed death benefit. If you take out a loan against the policy or make a cash withdrawal, your death benefit may be reduced. Otherwise, the death benefit usually remains the same when you die.

An IUL policy may give you the option to raise and lower the death benefit when you need to change your coverage. With an IUL, your death benefit is not guaranteed. Say you choose to make small premium payments over the life of the policy, and the index associated with the insurance doesn't perform well. When you die, the insurance company will recoup any money that you owe from the value of the death benefit. Your beneficiaries may receive a much lower payout, or the payout may be completely forfeited.

Can You Lose Money in an IUL?

Indexed universal life insurance has a minimum floor rate to protect you from severe loss. However, if you don't have enough money between the cash account and the premiums paid to cover the cost of the insurance, you could potentially forfeit your death benefit.

Whole life insurance doesn't carry the same risk. Provided the insurance company remains solvent, your death benefit is guaranteed and you will always earn some interest on the cash value of your account.

What Are the Key Benefits and Drawbacks of Whole Life?

The benefits of whole life insurance include:

• Guaranteed death benefit
• Minimum rate of interest paid
• Ability to take policy loans and make cash withdrawals
• Cash value usually grows tax-free
• Straightforward design
• Premiums that remain steady following the payment schedule you established when you bought the policy
• Potential to earn annual dividends

The drawbacks of whole life insurance include: 

• Lower interest rates that may not keep up with the rate of inflation
• Costly monthly premiums
• Less flexibility to modify your life insurance over time
• Cash value grows slowly

What Are the Key Benefits and Drawbacks of IUL?

The benefits of indexed universal life include:

• Potential to earn higher interest rates
• Ability to take policy loans and make cash withdrawals
• Cash value usually grows tax-free
• Flexibility to adjust premium payments
• Lower premium payments than whole life
• Cash value may grow more quickly

The drawbacks of indexed life include:

• Risk that the death benefit could be reduced or forfeited
• Complex structure with complicated returns
• Unpredictable interests rates 

Which Type Should I Choose?

If your primary reason for purchasing life insurance is to pass on a death benefit, whole life is likely the best option. People who want to use insurance as an investment and can tolerate some risk may prefer indexed universal life.