Ep. 155 Whole Life vs. Indexed Universal Life

Several years ago, 4 of our family members decided to get a private pilot’s license. In order to pass the FAA exam, to fly legally as a general aviation pilot, you must have a certain number of hours where a certified flight instructor sits beside you and teaches you how to maneuver a plane around on the ground, do a pre-flight inspection, fill the plane with fuel, take off, fly the airplane and successfully land back on the ground.

Some students are able to accomplish these tasks sooner than others, but interestingly enough no matter how many hours you have driven an automobile none of those hours count towards completing your pilot training. In fact, many students pass their flight exam with flying colors having never driven an automobile in their life.

This is possible because flying an airplane and driving an automobile are uniquely different. Both automobiles and airplanes have an engine, brakes, lights, windows, doors and most airplanes have tires and brakes. But this is where the similarities between the two come to an end.

Cars have engines, transmissions and drivelines (or transaxles), which transmit the energy produced by the engine to the wheels for propulsion. The propulsion in automobiles is controlled by the driver with an accelerator, brake, shifter, steering mechanism and steering wheel. Airplanes also have engines for their power supply. But airplanes are controlled by elevators, flaps, ailerons, wings, and stabilizers, which the pilot governs with a rudder, a stick (yoke), a throttle and brake (when on the ground).

In the automobile world there is a saying, “Speed Kills.” Furthermore, you need to keep your tires on the ground in order to maintain control. But in the airplane world the saying is, “Speed is Life and Altitude is Life Insurance.” Fact is, you will never fly if you keep your tires on the ground.

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Participating whole life insurance and indexed universal life insurance are about as different from each other as flying and driving. Yes, they both have face value, they both can develop cash value and each of these types of life insurance are classified as permanent life insurance. But this about sums up their similarities.

Indexed universal life is built on a term life insurance chassis which requires an ever increasing premium as long as the policy is owned. It has a flexible premium, meaning you can pay more than what the underlying term insurance would cost if you purchased it by itself. If you choose to pay more premium, the extra premiums paid will accumulate and can then earn an interest rate based on how a market index performs. This interest rate is capped at 10% to 15%, so an indexed universal life policy cash value growth is limited.

If you don’t pay your premium or enough premium to renew the underlying term coverage, of the indexed universal life insurance policy, the cash value is used to pay the premium and the outstanding policy loan accrues an interest charge. This interest can, and frequently does, force the policy to lapse as the accumulated cash values are destroyed by the loan balance and interest.

All premiums paid in an indexed universal life insurance policy are charged a fee. This fee is customarily around 6%. There is also an annual policy fee assessed on an indexed universal life insurance policy but there is NO equity developed in these policies. This means you are always renting the death benefit in an indexed universal life insurance policy, you never own it. Another fact about indexed universal life is the death benefit never gets bigger unless you pay additional premiums for a rider to make this happen. If you cancel an indexed universal life policy, any accumulated cash value will be refunded to you.

Participating whole life insurance develops equity which is called paid-up insurance. The longer you pay premiums the more of the policy’s death benefit you own. If you cancel a participating whole life insurance policy, the insurance company is required to buy back the equity (paid-up insurance) you have developed in the policy. Furthermore, there are NO fees paid on premiums used to purchase whole life insurance. The annual fee for the policy is fixed so more of your premiums can go toward purchasing paid-up life insurance, which is different than paying an ever-increasing premium for term insurance in a indexed universal life policy.

Participating whole life insurance, with its fixed level premium for life, can never increase but it can be reduced by the policy holder. Many participating whole life insurance policies reach a point where no further premiums are required from the policyholder to keep the policy growing. At this point the policy can be reduced and paid-up. When a policy is reduced and paid-up, cash values continue to grow because the guarantee in participating whole life is that the cash value has to equal the death benefit upon maturity. They are literally designed to get better every year, guaranteed.

As with an airplane, participating whole life insurance is designed to fly, while indexed universal life is designed for another reason. What the insurance companies always tell me is, “Indexed universal life was designed and sold to shift the risk back onto the policy owner and away from the insurance company”.

This shift in risk has forced many indexed universal policy owners to crash, losing their life insurance coverage because they could NO longer afford to pay the ever-increasing premiums required to keep their policy flying. If you want to fly, you need a plane. You can’t fly a car. If you want to be guaranteed your life insurance will last your whole life, you need a whole life insurance policy.

Today there are 5 of us in the family who have our pilot’s licenses and two more are in the process of learning so they can take the FAA pilot exam. It is important to know the difference between driving a car and flying an airplane as the knowledge and skill sets are different.

The same is true about life insurance. Indexed universal life insurance and participating whole life insurance are completely different vehicles. Don’t be led to believe indexed universal life insurance can replace the guarantees of participating whole life insurance can, it isn’t engineered to withstand the rigorous requirements which are required with participating whole life insurance.

In other words, don’t expect you can fly merely because you can drive a car.

Dr. Tomas P. McFie

Most Americans depend on Social Security for retirement income. Even when people think they’re saving money, taxes, fees, investment losses and market volatility take most of their money away. Tom McFie is the founder of McFie Insurance which helps people keep more of the money they make, so they can have financial peace of mind. His latest book, A Biblical Guide to Personal Finance, can be purchased here.