Indexed universal life is permanent life insurance whose cash value growth is linked to a market index, often the S&P 500, without directly investing in it. A floor, usually 0%, protects your principal from market losses, while a cap, commonly 8-12% depending on the carrier, limits how much of a strong market year you actually capture.
If the index is flat or down for the year, your cash value credits 0%, not negative. Your principal doesn't lose ground to a bad market year.
If the index gains more than your cap rate, you're credited up to the cap, not the full gain. A 10% cap in a 20% market year still credits 10%.
Some contracts use a participation rate instead of or alongside a cap, crediting a percentage of the index's gain. A 70% participation rate on a 10% index gain credits 7%.
An IUL policy doesn't buy shares of the index. The insurance carrier uses options tied to the index's performance to calculate your credited interest, while your premium (after cost of insurance and fees) sits in the carrier's general account. That structure is what allows the floor to exist: you're not exposed to the index's downside, only a formula based on its upside.
Caps, floors and participation rates vary by carrier and can change over time within contract limits. Guy compares current illustrations across carriers rather than quoting one company's best historical case.
Your cash value won't be credited negative interest from index performance because of the floor, typically 0%. You can still lose value from policy fees and the cost of insurance outpacing credited interest, especially in early policy years or if the policy is underfunded.
Because of the cap, an IUL rarely captures a strong market year in full, and because of the floor, it avoids a down year entirely. Over a full market cycle, many illustrations show mid-single-digit average credited rates, though actual results depend on the specific contract and market path.
A 401(k) index fund is directly invested in the market, capturing its full upside and downside. An IUL trades some upside (the cap) for downside protection (the floor), inside a life insurance policy that also provides a death benefit.
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