Americans are turning to cash-value life insurance as a way to add tax diversification to their investible assets. Two types of cash-value life insurance policies are Dividend-Paying Whole Life (WL) and Indexed Universal Life (IUL).
✅ Whole Life, a mainstay of the insurance industry for nearly 100 years, works like this:
➔ The policyholder pays a premium to the insurance company to initiate the policy.
➔ The annual premium supports a given death benefit based on:
- The minimum interest rate the insurance company estimates it could credit in a "worst-case scenario," and,
- The maximum mortality and expense charges.
➔ Insurance company actuaries determine actual experience and make adjustments to initial premiums by declaring annual dividends, which can:
- Increase the policy's cash value,
- Purchase additional death benefits, or
- Be used to pay next year's premium.
✅ Indexed Universal Life, developed in the late 1990s, works like this:
➔ The policyholder pays a premium to the insurance company to initiate the policy.
➔ The annual premium is more than required to support a minimum death benefit, allowing additional cash value to accumulate in the policy.
➔ Annual expenses and mortality charges are established and charged each year.
✅ When evaluating WL or IUL, it's important to consider three factors that can impact consumer experience and value:
- Financial Ratings of the Company– A life insurance policy is a long-term financial commitment. Regardless of policy type, it's best to use sound, highly rated insurers.
- Emphasis on Savings Component versus Death Benefit Component– If structured properly, WL and IUL policies can be used for the twin needs of cash value accumulation and death benefit protection. Many savers want death benefit protection but don't want to sacrifice cash value growth for more protection than they need. The IRS has established a set of rules that specify the minimum death benefit component that will allow an insurance policy to qualify for tax-free savings treatment.
- Interest Crediting Method– How interest is credited is very different between WL and IUL. In a WL policy, credited interest is tied to internal carrier decisions through annual dividends. In an IUL policy, credited interest is tied to an external index, such as the S&P 500, subject to an annual floor and cap.
Whole Life and Indexed Universal Life use different approaches to delivering value to policyholders. In general, WL policies tend to favor a higher death benefit at the expense of cash value growth. Conversely, IUL policies tend to favor cash value growth while keeping the death benefit closer to the IRS minimum.
As with any financial decision, the needs of the client (death benefit, tax-free income, or wealth transfer) will determine which product is the best fit.
At The CP Welde Group, we help clients evaluate whether Whole Life, Indexed Universal Life, or another strategy fits best within their broader retirement and tax plan. Schedule a complimentary consultation to talk through your options.
About the Author: Charles Welde, CPA, CFP®, is a financial advisor and founder of The CP Welde Group, a wealth management firm based in Chadds Ford, PA. He specializes in retirement income planning, tax-efficient strategies, and holistic wealth management for high-net-worth individuals, families, and business owners throughout the greater Delaware County area. Charles is also a member of Ed Slott’s Master Elite IRA Advisor Group and host of the Re-Engineering Your Finances podcast.
Originally published in Newtown Edgmont Friends & Neighbors.
Frequently Asked Questions About Permanent Life Insurance
What is the difference between Whole Life and Indexed Universal Life insurance?
Whole Life insurance uses a fixed premium structure with dividends declared annually by the insurance company, which may help build cash value or offset future premiums. Indexed Universal Life ties credited interest to an external market index, such as the S&P 500, within a set floor and cap. The two products differ most in how cash value could grow and how much flexibility is built into the premium.
Is cash-value life insurance a good way to diversify against taxes?
Cash-value life insurance may offer tax-deferred growth and, depending on how it is structured and owned, an income-tax-free death benefit.
How do insurance company financial ratings affect a life insurance policy?
Because a life insurance policy is a long-term commitment, often held for decades, the financial strength of the issuing carrier matters. Highly rated insurers are generally better positioned to meet their long-term obligations to policyholders.
What is the minimum death benefit required for tax-free treatment?
The IRS sets rules specifying the minimum death benefit a policy must carry relative to its cash value in order to qualify for tax-advantaged treatment. These rules apply to both Whole Life and Indexed Universal Life policies and are a key reason policy design matters.
Which is better: Whole Life or Indexed Universal Life?
Neither product is inherently better. Whole Life policies tend to favor a higher death benefit with more predictable growth. Indexed Universal Life policies tend to favor cash value accumulation while keeping the death benefit closer to the IRS minimum. The right fit depends on whether the goal is death benefit protection, tax-free income potential, or wealth transfer.