Indexed universal life (IUL) insurance is one of several types of permanent life insurance. Like other permanent life policies, it will never expire as long as you keep paying the premiums, and it offers both a death benefit and a savings account that allows the cash value of your policy to increase.

To understand the basics of indexed universal life insurance, it helps to break down the components of the term. First, the word "indexed" refers to the fact that the interest rate for the policy's savings account is tied to a stock market index. Second, the word "universal" indicates a policy in which the premiums and the death penalty are flexible rather than fixed. Another name for universal life insurance is adjustable life insurance.

How Does Indexed Universal Life Insurance Work?

Each insurance company chooses the stock market index (or indices) to which its IUL policies will be linked. For example, it might be the Nasdaq Composite or the S&P 500. The insurer then calculates the interest rate it pays on the funds in your cash value account based on the performance of that index. If the stocks in that index perform well, you'll earn more interest. If they do poorly, the value of your account won't grow as much. Most indexed universal life policies offer a guaranteed minimum interest rate.

Although insurers use stock market indices to set the interest rates they pay on IUL policies, they do not invest the funds directly in the market.

What Are the Benefits of Indexed Universal Life Insurance?

Two key benefits of IUL policies are investment growth opportunity and flexibility. Your policy's cash value has the potential to grow significantly, and because most policies offer an interest rate guarantee, your investment risk is moderate.

Your flexibility options kick in once your policy's cash value account has accumulated a bit. Like other universal or adjustable life insurance policies, IUL policies let you reduce or pause your premium payments as long as you have enough funds in your account to cover them. If you lose your job, have a medical emergency or face other financial strains, that temporary relief from your monthly insurance expense can help tie you over.

You also may be able to increase your policy's death benefit, or face value, after your cash value account reaches a certain level. Some insurers require a medical examination before allowing you to take that step.

In addition to the flexibility and growth potential that IUL policies can provide, they also allow you to borrow money against your earnings when you've built up a sufficient cash reserve.

What Are the Drawbacks of Indexed Universal Life Insurance?

Once you start digging into all the different layers of how indexed universal life policies work, they can get complicated. This can sometimes make it difficult to compare them to other insurance and investment options to determine whether they suit your financial planning needs.

Another drawback for IULs is their higher cost vs. term life insurance. Insurers pass along their costs for managing the saving and investment accounts of IULs and other permanent policies through higher premiums.

Is Indexed Universal Life Insurance Right for You?

Some important questions to consider before buying IUL insurance include:

• Is a permanent life insurance policy a good idea for me and my family?
• Do I want and need life insurance that offers investment growth opportunities as well as a death benefit?
• Can I afford the higher premiums of an IUL policy and keep up with the payments so my coverage doesn't lapse?
• Can I consult with an insurance agent or other financial advisor who can walk me through the workings of IUL insurance for my personal situation?

Indexed universal life insurance offers more financial flexibility than fixed-rate universal policies, plus a cash-building benefit that term life insurance doesn't have. If those features are a high priority for you in choosing a life insurance policy, then IUL insurance may be a viable option.