Life Insurance: Index Universal Life vs. Whole Life

One of the most common questions we are asked by both consumers and life insurance agents: Which one is better, Index Universal Life or Whole Life? Here's the answer. Almost everyone wants to get the best deal, the best value, the most return on their investment, and almost everyone wants to avoid significant risk when possible. This is true with life insurance as much as with any other product. Unfortunately, life insurance is relatively complex, and to add to the confusion there are a lot of opinions on the Internet that are NOT based on actual facts. These fallacious opinions are almost always offered by people with an agenda contrary to consumers best interest, usually based on willful ignorance, myopia, confirmation bias, mental accounting, and even stupidity. A savvy consumer uses a professional life insurance agent to examine the facts, and then chooses the policy, or portfolio of policies recommended by their agent that best solves all of their problems. Invariably, permanent life insurance decisions fall into two distinct objectives: Highest Internal Rate of Return (IRR) on Death, or Highest Internal Rate of Return on Cash Value Accumulation. Some policies try to solve both problems, but that is almost always a sub-optimal solution, because no policy can do both extremely well. If you're buying life insurance for liquidity at death, the policy design and premium structure will differ greatly from a life insurance purchase to fund stream of income at retirement. This should be intuitive, but we routinely find policy owners that own the wrong kind of insurance for their current financial planning objectives. For example, we find that some people who own permanent life insurance that really should own term insurance. Likewise, we find policy owners that own term insurance that really should own a permanent cash value policy, either because their needs are never going away, or they suffer from reverse discrmination in the retirement funding area. These permanent life insurance policy needs include: Cash for estate preservation due to income taxes, federal estate and gift taxes, state inheritance taxes, and capital gains taxes due, Cash business continuity and executive succession Phantom income tax reduction using group-term carve out Funding for excess benefit plans to correct reverse-discrimination in the qualified plan arena (nonqualified deferred compensation, select exectutive retirement plans, executive bonus plans, split dollar plans, death benefit only plans, etc.)  Funding for defined benefit pension plans Wealth replacement for Charitable Remainder Trusts Pension Maximization for workers eligible for a Defined Benefit Pension Social Security Maximization and, Supplemental Retirement Income To obtain the maximum IRR on death, one needs the highest death benefit in relation to the premiums paid. On the other extreme, in order to obtain the maximum IRR on cash values, one must pay the highest premium in relation to the death benefit. When the need for death benefits we identify are permanent, AND/OR there's a need for cash value accumulation, the two policies that are most commonly compared are Index Universal Life and Dividend Paying Whole Life. This begs the question: Which one is better? You decide... Type of Life Insurance: Index Universal Life Whole Life (dividend paying) Premiums Flexible Fixed Death Benefits Adjustable Fixed Cash Values Cash values grow with Index Linked Interest - market sensitive, with participation rates and/or interest rate caps set at the discretion of the insurance company, subject to guaranteed minimums/maximums set in the policy. Potentially higher interest than current fixed yields, with a hard floor (interest can never be less than zero, may be guaranteed to be as much as 3.00%).  Guaranteed cash values based on an assumed interest rate, usually 3% or 4%, plus non-guaranteed dividends, either a portfolio yield or new money rate, declared annually by the insurance company, based on the investment returns in the insurance company’s general account. Policy Loans Yes Yes Loan Interest Rate Fixed OR Variable, policy owner choice Fixed or Variable, determined by policy Tax Free Retirement Yes, when properly structured, policy can produce a lifetime of tax-free retirement income, as long as the policy stays inforce until death. Yes, by surrendering dividends to cost basis, then policy loans. Some policies may perform better by using only policy loans. Overloan Protection Yes Maybe Policy can be used as a Family Bank Yes Yes Arbitrage Potential Yes, with Variable Loan Interest Maybe, if policy uses Non-Direct Recognition Dividend scales. Sizzle - The Unique Owner Benefits Maximum Cash Accumulation Potential, with index linked interest credits upwards of 13-14% or more per year, with principal protection -- No market risk, cash values never lose when the stock market index is negative. Flexible premiums andadjustable death benefits. Guaranteed Cash Valuesscheduled in contract, plus standard non-forfeiture options -Reduced Paid-Up and Annuitization (partially taxable). Downside Positive stock market index growth is NOT guaranteed. What this means to you is that cash values may earn zero percent interest when index is negative, but that's actually a positive result. Dividends are NOT guaranteed. Industry wide, dividends have been trending downward for the last two decades, as long term interest rates on bonds have trended downward. Whole life premiums and death benefits areNOT flexible, generally. Which one should you own? If you want maximum non-guaranteed cash value growth potential for either a lump sum cash need, a tax-free retirement income stream, or maximum non-guaranteed internal rate of return on death, and you want or need a flexible premium structure, then Index Universal Life may be the superior choice for you. If you want guaranteed cash value growth with some sacrafice on the potential upside during periods of stock market index growth, or if you want the guaranteed option to elect a Reduced Paid-Up policy at some point in the future, and you have substantial discretionary cash flows so that the non-flexible premium schedule does not present a problem, then Dividend Paying Whole Life maybe the superior choice for you. Amateur agents always recommend the same type of policy, regardless of the needs of the client.Professional agents recommend the policy, or portfolio of policies, that best solves your problems and meets your needs. The purchase of life insurance is a serious decision, with significant financial implications for you, your business, and your heirs. That is why it is always a good idea to use a professional insurance agent when purchasing life insurance. The best choice is an insurance agent that has earned the professional designation Chartered Life Underwriter.