Indexed Universal Life (IUL) insurance is a unique form of permanent life insurance that has grown in popularity recently. IUL combines the death benefit and tax-deferred savings components of traditional whole and universal life insurance with interest-crediting tied to the performance of financial indexes, like the S&P 500.
This article will provide a comprehensive guide to IUL policies, how they work, their pros and cons, and things to consider when buying IUL insurance in Canada.
We’ll compare IUL to other types of life insurance, walk through illustrations and scenarios, and equip you with questions to ask when shopping for the best IUL policy for your needs.
Whether you are considering IUL for yourself or want to understand this insurance product better, this guide will help you become an informed consumer.
What is Indexed Universal Life Insurance?
IUL is a form of permanent life insurance designed to provide lifetime coverage as long as premiums are paid as required. Like all permanent life insurance, IUL has two core components:
Death Benefit – This is the amount that beneficiaries receive tax-free upon the insured’s death. It is the primary purpose of the life insurance policy.
Cash Value Account – This savings-like account builds value over time that the policyholder can access via policy loans and withdrawals. The cash value growth is tax-deferred.
The key feature that makes IUL policies unique is how they calculate interest credited to the cash value account. With IUL, the cash value earns interest based on increases in an external equity index, such as the S&P 500.
The insurance company does not directly invest IUL cash value funds in the stock market. Instead, they use complex options contracts to link the returns to indices like the S&P 500 or NASDAQ. This provides market-driven returns while limiting downside risk.
IUL insurance offers this equity index-linked growth potential while also providing the following:
- Lifelong permanent coverage
- Flexible premium payments
- Adjustable death benefit amounts
- Downside protection through rate floors
- Upside potential capped by participation rates
In Canada, IUL policies are offered by most major life insurers, such as SunLife, Canada Life, RBC Insurance, and Manulife. They appeal primarily to high-net-worth individuals as part of estate planning, business strategies, or supplemental retirement savings.
How Do IUL Insurance Policies Function in Canada?
Now that we’ve covered the basics of IUL, let’s examine how these policies work.
Premium Payments
As with other permanent life insurance, the premium payments you make go towards two uses:
- Paying the monthly costs of insurance (underwriting expenses, administrative fees, etc.)
- Funding the policy’s cash value account
A portion of each premium payment covers that month’s insurance costs. The remainder gets credited to the cash value, where it can accumulate on a tax-deferred basis.
A key advantage of IULs is premium flexibility. As with universal life insurance, you have the flexibility to pay more or less than the policy’s target premium. Paying more can drive cash value growth, while underpaying may require tapping into cash reserves to keep the policy active.
This flexibility empowers policyholders to align premiums with changing financial situations over the policy’s life.
Cash Value Account
The cash value account is where the equity index-linked growth potential comes into play. Any index gains are calculated monthly or annual and credited to the cash value, up to a capped maximum.
Most IUL policies offer two types of interest-crediting accounts:
Fixed Account – This option earns a set interest rate that is declared annually by the insurer. It acts much like the cash value account in whole life and universal life policies.
Indexed Account – This account is tied directly to the performance of a market index like the S&P 500 or S&P/TSX 60. The interest credited is linked to the gains in the index over a specific period within limits set by the insurer.
As the index rises, so does your cash value (up to a maximum cap or participation rate). When the index falls, your account is protected from losses by a guaranteed minimum floor, usually 0-3%.
This blends a measure of upside stock market potential with downside protection against losses in volatile markets.
Here is a comparison of standard indexing options offered for IUL policies in Canada:
| Index | Typical Participation Rate | Cap Rate | Floor/Minimum |
| S&P 500 | 80-100% | 10-15% | 0-3% |
| S&P/TSX 60 | 80-100% | 10-15% | 0-3% |
| EURO STOXX 50 | 50-80% | 8-12% | 0% |
| Hang Seng (Hong Kong) | 50-80% | 6-10% | 0% |
Adjustable Death Benefit
One of the flexible options included with IUL policies is the ability to increase or decrease your death benefit amount within specific parameters set by the insurer. Reasons you may adjust death benefit amounts over time include:
- Change in income or need for life insurance
- Desire to fund policy through cash value growth vs premiums
- Response to health changes that alter required coverage
Increasing the death benefit often requires updated medical underwriting, while decreasing it may just involve policy adjustments. This adaptability helps align coverage with evolving needs.
Policy Loans and Withdrawals
Most IUL policies offer access to the accumulated cash value through policy loans and withdrawals. This can be beneficial for accessing funds in emergencies or supplementing income in retirement.
However, loans and withdrawals will reduce policy values, and unpaid loans are deducted from death benefits paid to beneficiaries. Caution should be used when tapping into IUL cash value to avoid jeopardizing the policy’s performance.
The Pros and Cons of IUL Insurance in Canada
IUL insurance can offer tax-free growth potential and death benefit coverage in a flexible policy. However, there are also limitations to consider. Look at indexed universal life insurance’s key pros and cons.
Pros of IUL Policies
Market Growth Potential – When the equity index rises, so can your cash value, allowing for returns linked to market gains. This enables growth potential above traditional fixed life insurance policies.
Downside Protection – When the index declines, your cash value is shielded from losses by a guaranteed minimum floor, usually 0-3% annually.
Tax-Deferred Savings – The cash value growth within an IUL policy accumulates on a tax-deferred basis, like a 401k or RRSP. Taxes are only owed if money is accessed via loans or withdrawals.
Premium & Death Benefit Flexibility – Ability to adjust premium payments and death benefit amount to align with changing financial situations and insurance needs.
No Required Medical Exam – IUL policies can often be purchased with no medical exam required, making coverage accessible to those with health issues. Exams may be required later for death benefit increases.
Policy Loans – The ability to access cash value through policy loans (with interest) can benefit emergency funds or supplemental retirement income.
Cons of IUL Policies
Caps Limit Returns – Participation rates limit the amount of index-linked gains credited to the cash value each period. In surging markets, returns will be below actual index performance.
Policy Fees & Expenses – All life insurance includes underwriting, administration, fund management, and commissions fees. IUL fees may be higher than those for simpler permanent life products.
Premium Commitment – If premium payments lapse, the policy can drain cash value quickly and face a higher risk of lapsing without proper monitoring.
Complexity – The indexed-based interest calculations make IUL policies more complicated to understand than basic term or whole life insurance. This complexity requires working with a knowledgeable agent/advisor.
Policy Surrender Charges – If the policy is cancelled early, surrender charges will apply, which can recapture some of your cash value. The surrender term is usually 10-15 years.
Tax Implications – Withdrawals and loans may have tax consequences if policy lapses or IRS guidelines are not followed. Indexed gains are treated as income versus capital gains when accessed.
Lack of Dividends – IUL policies do not pay dividends like some whole-life policies, so they are missing out on this added cash value gains source.
When weighing these pros and cons, the benefits of market-linked cash value growth and flexible premiums need to be balanced with the comparative complexity and conservative caps on upside potential.
How Does IUL Compare to Other Life Insurance Options?
Deciding between IUL and other types of life insurance depends on your priorities and needs as an insurance consumer. Let’s compare some key features of IUL policies versus common life insurance alternatives.
IUL vs. Whole Life Insurance
| Feature | Whole Life | IUL |
| Premiums | Fixed, lifetime | Flexible, adjustable |
| Cash value | Fixed interest rate | Indexed to market |
| Death benefit | Guaranteed | Adjustable |
| Policy cost | Lower | Higher |
- Whole life insurance guarantees death benefits, premiums, and cash value growth at a fixed interest rate.
- IUL offers the potential for higher but variable cash value growth tied to market indexes.
- IUL allows adjustment of death benefits and premium flexibility. The whole life does not.
- IUL is more complex with interest calculations; whole life is straightforward permanent coverage.
IUL vs. Universal Life Insurance
| Feature | Universal Life | IUL |
| Premiums | Flexible | Flexible |
| Cash value | Fixed interest | Indexed to market |
| Policy cost | Lower | Higher |
- Both IUL and Universal Life insurance offer flexible premiums and adjustable death benefits.
- Universal life cash value grows at the insurer’s declared fixed interest rate.
- IUL cash value growth is tied to gains in a market index from year to year.
- IUL credits interest up to a capped maximum; universal life has no upside limit.
IUL vs. Term Life Insurance
- Term life provides temporary death benefit coverage for a set period, like 10-30 years.
- IUL provides lifelong insurance coverage along with tax-deferred cash value growth potential.
- Term life premiums increase with age; IUL offers level premiums for life.
- In the early years, IUL is significantly more expensive than term life insurance but can become more cost-effective after conversion periods.
Understanding these key tradeoffs can help narrow your search to the right life insurance product to suit your budget and objectives. An independent insurance broker can also provide guidance specific to your situation.
What to Look For When Buying IUL Insurance in Canada
If you’ve weighed the pros and cons and decided an IUL policy may be a fit for your goals, here are key considerations as you shop for a top-quality policy:
Look for Top-Rated Insurers
In Canada, credible options include SunLife, RBC Insurance, Manulife, Canada Life, and others with strong financial strength ratings from agencies like AM Best. Avoid any providers with low ratings or excessive policyholder complaints.
Compare Indexing Options
Look for a provider that offers indexing options. These options allow you to allocate cash value between equity indexes, international indexes, bond indexes, and fixed-rate accounts. This diversification can help smooth volatility over time.
Review Index Cap Rates
Maximize potential gains by selecting a policy with the highest index cap rates and participation rates. Caps above 12% annually are ideal, and high participation rates (100%+) are optimal.
Understand Fees Charged
Administrative fees, fund charges, surrender charges, and other expenses vary significantly by insurer. Get illustrations outlining all recurring internal costs and factor them into your decision.
Assess Premium Flexibility
Policies with lower premium requirements often necessitate higher payments over time. Look for lifetime pay options to lock in lower guaranteed payments.
Examine Riders & Features
Consider common IUL riders like waiver of premium for disability, guaranteed insurability to increase death benefit, and accelerated payout options for terminal illness.
Work With an Independent Broker
An independent broker that deals with multiple insurers can help compare policies and illustrate long-term performance scenarios. This expertise pays dividends when optimizing IUL selection.
Researching providers, weighing policy details, and working with an expert broker gives you the highest chance of purchasing a top-tier IUL policy that aligns with your financial objectives.
IUL Policy Illustrations: Understanding Projected Returns
When applying for IUL insurance, providers will provide policy illustrations projecting your potential cash value accumulation and other benefits over time. However, it’s crucial to understand what these illustrations do and do not indicate when evaluating policies.
IUL illustrations provide hypothetical projections based on the assumed:
- Index growth rates
- Policy expenses
- Premium payments
- Cap rates
- Withdrawals or loans
They demonstrate how the policy may perform given a defined set of assumptions. Illustrations can help compare potential long-term outcomes between policies.
However, policy illustrations are not a guarantee of actual future performance. They are meant as a sales tool to help you assess a policy’s structure.
Below are tips for reviewing IUL illustrations while keeping realistic expectations:
- Compare multiple illustrations – Have your broker run new illustrations periodically using varying index return assumptions. Refrain from fixing on a single best-case illustration.
- Consider historical index returns – Review historic 10 and 20-year returns on the indexes used to benchmark reasonable growth assumptions.
- Factor in down markets – Periods of index declines will happen over the life of a 30 year policy. Don’t expect uninterrupted positive returns.
- Account for changing caps & rates – Illustrated cap rates often decrease over time or after policy renewal. Lower rates in later years can reduce cash value growth.
- Understand fees – Fees often gradually increase over the life of a policy as costs rise. Higher fees equate to lower net returns for policyholders.
- Consider minimum premiums – Paying only minimum premiums results in slower cash value accumulation compared to fully funding the policy over time.
While illustrations can be helpful to sales tools, having realistic expectations by digging deeper into assumptions and policy details is vital for making an informed IUL purchase.
Realistic IUL Policy Performance Scenarios in Canada
Let’s look at two examples to illustrate how IUL policies can perform quite differently for policyholders based on actual index returns and other variables:
Example 1 – Strong Sustained Returns
- Policyholder: 45 year old male, Preferred Plus rating
- Death Benefit: $500,000
- Annual premium: $6000
- Index Account: 100% allocation to S&P 500 index
- Index Returns: Avg 11% over 20 years
In this scenario, the policyholder allocates all cash value to an account tracking the S&P 500 index, which averages 11% annual returns over the next 20 years.
Given the sustained bull market with high single digit returns, the policy cash value grows rapidly. By year 20, the cash value reaches $128,000.
At this point, the accumulated cash value is sufficient to fund all future insurance costs and premiums are no longer required. The death benefit continues intact and is funded by cash value.
Example 2 – Variable Returns with Downturn
- Policyholder: 50 year old female, Standard rating
- Death Benefit: $400,000
- Annual premium: $3000
- Index Account: 50% S&P 500, 50% Nasdaq-100
- Index Returns: Avg 7% over 20 years but with a 40% downturn in years 8-10
In this scenario, the policyholder divides the cash value evenly between two equity indexes. Although average returns are a healthy 7% over the full 20-year term, the market plunges 40% during years 8-10 before recovering.
Due to the severe 3-year bear market, the policy cash value only reaches $45,000 by year 20. This is not enough to discontinue premiums.
Without sufficient cash value gains, the policyholder must continue paying $3000 annually to maintain the desired death benefit. The downturn hampered cash value growth.
These examples illustrate how actual index returns can significantly influence policy performance and out-of-pocket premium costs over decades of coverage.
12 Key Questions to Ask When Buying IUL Insurance
- How long have you offered IUL policies? Look for experienced providers who have offered these policies for 10+ years.
- What indexes can I link my cash value returns to? Look for standard equity indexes like the S&P 500, Russell 2000, TSX 60, etc.
- What are your current cap rates and participation rates? Compare these key percentages between insurers. Higher is better.
- Can you provide multiple illustrations using different index return assumptions? Illustrations can vary widely depending on projected index growth rates.
- What fees and expenses are included in this IUL policy? Understand all recurring internal fees charged annually or monthly.
- How often have you adjusted caps and participation rates historically? Ask for data on past rate adjustments to set expectations.
- Is there a “no lapse guarantee” protecting against premium increases? No-lapse features can provide peace of mind.
- What riders are available to customize my coverage? Consider riders for waiver of premium, guaranteed insurability, and payout options.
- What is your process if I need to make changes to my policy in the future? Understand how adjustable the policy is over time.
- How would a market downturn impact my illustrated cash values? Index declines can dampen growth, so projections rarely move smoothly upward.
- How stable is your financial strength rating for paying claims? Only consider insurers with ratings of A or higher.
- Why should I choose your IUL product over competitors? Get details on the unique advantages of the policy being proposed.
Asking the right questions allows you to fully evaluate IUL policies against your specific situation and financial goals.
Limitations and Challenges of IUL Insurance in Canada
While indexed universal life insurance offers unique benefits, it also comes with some inherent limitations and challenges that Canadian consumers should understand:
Narrower Market – IUL remains a relatively niche product in Canada compared to the US. Fewer insurers offer it, and consumer awareness needs to catch up to other policy types, which can limit options.
Domestic Index Focus – Most Canadian IUL policy indexes focus on domestic indexes like the TSX 60 rather than offering global index diversification.
Lower Caps and Rates – Canadian IUL policies tend to have lower cap rates and participation rates than US policies, limiting upside potential. Average caps are 10% or below.
Lack of Policy Data – With fewer providers, less historical policy data is available to assess long-term policy performance and fee adjustments in Canada.
Tax Complexity—The Canadian tax treatment of loans and withdrawals adds complexity to IUL financial planning scenarios. Advisors who are less familiar with IUL can make mistakes.
Illustration Assumptions – Given limited Canadian data, some insurers may present aggressively optimistic illustration assumptions that will play out differently over decades.
Being aware of these inherent challenges and limitations allows consumers to enter an IUL policy with their eyes wide open to the realities of the Canadian marketplace.
Conclusion: Who is IUL Right For?
Indexed universal life insurance can offer benefits like lifelong coverage, tax-deferred cash value growth linked to market upside, and flexibility to adjust the policy over time. It provides a helpful balance of growth potential while limiting downside risk.
However, IUL is certainly only suitable for some. The added complexity, fees, and conservative caps on returns compared to direct equity investing make IUL more advantageous for:
- High-net-worth individuals
- Those wanting to supplement retirement savings in a tax-efficient vehicle
- Business owners funding buy-sell agreements or executive benefits
- Families needing permanent life insurance and some added growth potential
The upside potential comes with tradeoffs, such as added cost, complexity, and moving parts to monitor compared to basic term or whole life.
If you have reviewed the pros, cons, illustrations, and policy details with the help of an expert independent broker, understand the tradeoffs, and still find IUL aligns with your financial objectives, it can be a beneficial addition to your insurance portfolio.
Just be sure to invest the time upfront to grasp how these policies work fully, what drives actual long-term performance, and what questions to ask providers to get an optimal indexed universal life insurance policy that suits your unique needs and priorities.
FAQs related to Indexed Universal Life Insurance in Canada
How does indexed universal life insurance work in Canada?
IUL policies in Canada work similarly to the US. Premiums fund the policy's costs and cash value account. Interest credited to the cash value is linked to gains in a stock index, between an upper cap and lower floor rate. Policyholders have flexibility to adjust premiums and death benefit amounts.
What are the top indexed universal life insurance companies in Canada?
Some of the top companies offering IUL policies in Canada include Sun Life, Manulife, RBC Insurance, Canada Life, Equitable Life, and Foresters Financial.
Where can I get indexed universal life insurance quotes in Canada?
You can get IUL quotes from a licensed life insurance broker or advisor in Canada. Many insurers also offer instant online quote tools. An independent broker with multiple carrier access often provides the best rate comparison.
Why choose indexed universal life insurance over whole life in Canada?
The main advantage of IUL over whole life is the equity index-linked cash value growth potential. IUL policies may accumulate value faster long-term and provide more upside tied to stock market performance.
When should you avoid indexed universal life insurance in Canada?
IUL may not be the best choice if you want simple permanent protection with guaranteed premiums and cash growth. It also may not suit those unwilling or unable to monitor index performance and policy cash values annually.
Do indexed universal life insurance policies have dividends in Canada?
No, IUL policies in Canada do not pay dividends. Only participating whole life policies typically pay dividends based on insurer financial performance. IULs do not participate in company profits.
Can indexed universal life insurance lose money in Canada?
IUL cash value cannot lose money due to market declines in Canada because policies guarantee a minimum floor interest rate of 0-3% annually. However, growth may lag in down markets compared to other equity investments without downside protection.
Is the death benefit on indexed universal life insurance taxable in Canada?
No, the IUL death benefit received by beneficiaries in Canada is generally income tax-free, similar to other types of life insurance. It is not taxed as income or considered part of the insured's estate.
What are indexed universal life insurance policy illustrations in Canada?
Illustrations estimate hypothetical future cash value growth projections to demonstrate how an IUL policy may perform long-term under varying assumed index return scenarios. Illustrations help compare policies but are not a guarantee.
What fees and charges apply to indexed universal life insurance policies in Canada?
Common IUL fees in Canada include cost of insurance, administrative and policy fees, fund management expenses, surrender charges, and riders costs. Fees vary by insurer and may increase over time.
