Index Universal Life Insurance for Expats: Pros, Cons and Cross-Border Considerations

However, this form of insurance also comes with caps and participation limits on returns, and it requires ongoing monitoring because performance depends on non-guaranteed crediting rates determined by the insurer.

For internationally mobile clients, IUL policies can play a role in long-term wealth protection or estate planning, but the tax and regulatory treatment varies significantly between jurisdictions such as the United States, the United Kingdom and Australia.

To help you assess whether an IUL policy fits your retirement and inheritance objectives, this article outlines the key advantages and potential drawbacks of index universal life insurance from an expat’s perspective.

What Is Indexed Universal Life Insurance?

Indexed universal life (IUL) insurance is a type of permanent life insurance that provides lifelong coverage as long as required premiums and policy charges are paid. Upon the policyholder’s death, their beneficiaries receive a payout known as the death benefit.

In most jurisdictions, including the United States, the death benefit is generally income-tax free for beneficiaries.

However, in the United Kingdom it may form part of the estate for Inheritance Tax (IHT) purposes unless the policy is written in trust, and in Australia the tax outcome depends on whether the policy is held inside or outside superannuation and the beneficiary’s relationship to the insured.

The death benefit can be used to:

• Cover funeral expenses.
• Settle any outstanding debt.
• Fund education costs.

Provide financial security for the policyholder’s heirs.

IUL policies also have a cash value component held within the insurer’s general account, which accumulates value through interest credits rather than direct market investment. Unlike traditional universal life insurance, which grows at a fixed rate set by the insurer, the credited interest on an IUL is linked to the performance of an external market index, such as the S&P 500, subject to caps, participation rates, and floor limits.

The policyholder can access the cash value by taking policy loans, making partial withdrawals (subject to tax and policy conditions), or surrendering the policy.

How Do Indexed Universal Life Insurance Premiums Work?

When you take out an IUL policy, you agree to pay premiums that keep the coverage active for life. Premiums consist of two components:

1. Cost of insurance (COI): The minimum amount required to sustain the policy, funding the death benefit and administrative charges. The COI varies based on age, health, gender, and the level of coverage.
2. Cash value: The remaining portion of your premium contributes to the policy’s cash value and may earn indexed or fixed interest, depending on the allocation you select.

How Does an IUL Build Cash Value?

After your premium is paid, the insurer deducts the cost of insurance and other charges. The balance is allocated to one or more indexed accounts (and sometimes a fixed account) within the insurer’s general account. Funds are not directly invested in stocks or bonds; instead, the insurer credits interest based on index movements, typically excluding dividends.

The credited interest is usually calculated over fixed “index segments,” most commonly annually, though some insurers use monthly or averaging methods. These may include:

• Daily average method: This method calculates the average value of the index over a certain period, usually a month or a year
• Monthly point-to-point method: It adds the monthly gains and subtracts monthly losses for each month over a twelve-month period
• Annual point-to-point method: It records the index value at the start and end of the policy year and uses the difference between the two values to calculate the interest rate

Some IUL providers also offer a fixed-interest account alongside indexed options. The fixed account earns interest at a declared rate set by the insurer, providing steady, non-market-linked growth.

While the indexed crediting approach allows for upside participation, it is subject to non-guaranteed elements such as caps, participation rates, and spreads that the insurer may adjust over time.

Policy charges continue to apply even in years when the index credit is 0%, meaning cash value can still decline.

Pros of Indexed Universal Life Insurance

IUL insurance is an attractive option for expats seeking the flexibility of traditional universal life insurance while benefiting from market-linked growth potential and downside protection through a guaranteed minimum credit (“floor”). However, these benefits depend on non-guaranteed crediting rates, participation levels and insurer performance.

Its key advantages are:

1. Adjustable premiums and death benefit.
2. Potential for high returns.
3. Floor rate.
4. Limited exposure to market downturns.
5. Tax benefits.

Adjustable Premiums and Death Benefit

IUL insurance offers flexibility in premium payments, allowing you to adjust contributions based on your financial situation. You may decide to lower or pause your premium payments, but your policy will remain active as long as the accumulated cash value is sufficient to cover the mandatory policy charges.

Conversely, you can contribute more than the minimum required premium to accelerate cash value growth. Over-funding can improve long-term policy performance but may also cause the policy to become a Modified Endowment Contract (MEC) in the United States, which changes the tax treatment of loans and withdrawals.

Most IUL policies also allow you to adjust the death benefit sum to accommodate changing insurance or estate planning needs. You can lower the death benefit if you don’t need as much coverage or want to reduce your premium costs. Some policies also allow you to increase your death benefit, though this typically requires a medical exam or additional underwriting.

Potential for High Returns

Unlike regular universal life insurance, IUL policies allow the cash value to grow based on the performance of a selected stock market index. Consequently, they offer the potential for higher credited interest during periods of strong stock market performance.

However, returns are subject to caps, participation rates, and spreads that limit the percentage of index growth credited to your policy. Actual credited rates will often be lower than total market returns because dividends are excluded.

In favourable markets, cash value accumulation may eventually reach a level where policy charges can be covered internally, sometimes described as a “self-funding” or “no-out-of-pocket” policy, but this depends on sustained index credits and is not guaranteed.

Floor Rate

The floor rate in an IUL policy is the minimum credited interest rate that protects the policy’s cash value from negative index performance. Most insurers guarantee a floor between 0% and 1%, which applies to index crediting only, and not to the overall policy value.

If the chosen index falls by 5%, the floor rate ensures that no negative index interest is applied, though policy charges and insurance costs may still reduce the cash value.

This protection makes IUL insurance generally less volatile than variable universal life insurance (VUL), which invests directly in sub-accounts that can rise or fall with the market.

Limited Market Exposure

IUL insurance allows you to benefit from stock market growth without being directly invested in equities. Your funds remain within the insurer’s general account, and returns are credited based on an external index using options and hedging strategies managed by the insurer.

While this approach removes direct market investment risk, you remain exposed to insurer credit risk, potential reductions in caps or participation rates, and the impact of ongoing policy charges in years when the index credit is 0%.

Tax Benefits

IUL insurance offers several potential tax benefits for expats focused on long-term wealth accumulation and estate planning. These advantages vary by jurisdiction and depend on policy structure, ownership and residence status.

• Tax-deferred growth: In the US, cash value growth is generally tax-deferred while it remains inside the policy. In the UK, gains are taxed only on a “chargeable event” (such as surrender or withdrawal), and in Australia, treatment depends on whether the policy is held inside or outside superannuation.
• Tax-efficient death benefit: In the US, death benefits are usually income-tax free to beneficiaries (subject to exceptions). In the UK, the death benefit may fall within the estate for IHT unless written in trust. In Australia, death-benefit tax depends on the recipient’s relationship to the deceased and whether the policy is held inside super.
• Policy loans and withdrawals: Loans are typically tax-free in the US if the policy remains in force and is not a MEC. Withdrawals up to the amount of premiums paid are generally tax-free, but amounts above that basis are taxable. In the UK and Australia, withdrawals can trigger taxable gains or assessable income depending on local rules.

Cons of Indexed Universal Life Insurance

IUL insurance entails several potential drawbacks you should consider before committing to a policy:

1. Caps on returns
2. Participation rates
3. Risk of policy lapse
4. Complexity and active management requirements
5. Higher fees and costs

Caps on Returns

IUL insurance policies impose a maximum interest rate that the insurer will credit to your cash value during a specific period, regardless of how well the underlying stock market index performs.

These caps are designed to control the insurer’s exposure to option costs and maintain the long-term sustainability of its crediting structure.

Caps are non-guaranteed and may change at the insurer’s discretion, typically on an annual basis, subject to minimum contractual guarantees. They can be set either on an annual or monthly level.

For instance, if the reference index grows by 15% and your cap is 10%, your cash value will rise only by 10%, even though the index outperformed that level.

Expats should note that crediting caps and participation rates can differ significantly between onshore and offshore policies due to regulatory and cost-of-hedging differences.

Participation Rates

The participation rate represents the percentage of the underlying index’s gain that is applied to your cash value growth. Insurers often combine caps, participation rates, and spreads to manage crediting risk and profitability.

Like caps, participation rates are non-guaranteed and can be adjusted during the life of the policy.

If your policy has an 80% participation rate, it means that only 80% of the index growth is credited to your policy. So, if the underlying index grows by 15% in a year, your credited return would be 12%. However, if the insurer also applies a 10% cap, your gains would be effectively limited to 10%.

These adjustments are important to monitor, as persistent reductions in participation rates or caps can materially lower long-term policy performance.

Example of potential outcomes:

Risk of Policy Lapse

A policy lapse can occur when the cash value is insufficient to cover the monthly cost of insurance and other charges. This can happen if the index crediting rates are lower than projected, whether due to weak market performance, reduced participation rates, or capped returns.

As the policyholder ages, the cost of insurance increases, which can further erode the cash value if returns do not keep pace.

Loans or withdrawals also reduce the available cash value and can accelerate the risk of lapse, particularly if the policy is over-leveraged.

In addition, consistently paying below the required minimum premium or missing payments for an extended period may cause the insurer to lapse the policy, potentially triggering taxable gains if the policy has outstanding loans or has been classified as a Modified Endowment Contract (MEC) under US tax rules.

In the UK, a lapse or full surrender can give rise to a chargeable event gain taxed as income, and in Australia, the tax treatment depends on whether the policy is held inside or outside superannuation.

Complexity and Active Management

IUL insurance policies include multiple variables that may impact your return rates, such as market performance and cap, floor, and participation rates.

This complexity means regular monitoring and periodic reviews are essential to ensure the policy continues to meet its intended objectives.

For many expats, this level of oversight may require professional advice from an independent financial adviser, similar to Titan Wealth International, who are familiar with cross-border taxation and offshore insurance structures.

Failure to actively manage funding levels, loan balances, or crediting assumptions can lead to underperformance or policy lapse.

Higher Costs and Fees

IUL insurance policies tend to have higher costs and fees compared to traditional universal life insurance. The costs can grow over time, potentially eroding your cash value or increasing the minimum required premium payments. These expenses stem from several sources:

• Cost of insurance charges: The insurer’s risk increases as you age, which results in higher COI charges. If you don’t adjust your premium payments accordingly, these costs can deplete your cash value balance and impact its long-term growth.
• Administrative and premium charges: IUL policies involve complex analysis to manage the allocation of interest based on stock market performance and various growth limits. To compensate for these challenges, insurers typically impose higher administrative fees, especially in the early years of the policy’s life.
• Rider fees and additional charges: Some IUL policies offer optional riders or add-ons that tailor the policy to your specific needs. Including a child rider or a waiver of premium rider can significantly affect the overall insurance costs.

Charges, spreads, caps, and participation rates are generally reviewable by the insurer, and future costs may differ from those illustrated at policy inception.

Who Should Buy IUL Insurance?

In general, indexed universal life (IUL) insurance is best suited for financially sophisticated or high-net-worth expats seeking to grow and transfer wealth in a potentially tax-efficient and internationally portable structure.

In particular, an IUL policy may be appropriate for:

• Expats with long-term retirement and estate-planning goals: IUL insurance offers the potential to build cash value that can supplement future retirement income through policy loans or withdrawals, provided the policy remains in force. It also allows expats to leave a generally income-tax-free death benefit for beneficiaries, though the tax treatment varies. For instance in the UK, proceeds may be subject to Inheritance Tax unless held in trust; in the US, proceeds are usually income-tax free under IRC §101; and in Australia, treatment depends on whether the policy is held inside or outside superannuation and the beneficiary’s status.
• Expats seeking flexible premium and death-benefit options: The ability to adjust premium levels and death-benefit amounts makes IULs attractive for expats whose income or financial commitments vary with international assignments or currency exposure.
• Expats willing to monitor and actively manage their policy: IUL policies require regular review of crediting rates, caps, participation levels, and funding patterns to ensure adequate cash value is maintained. Failure to manage the policy may increase the risk of lapse or taxable events, especially if loans are taken against the cash value.
• Expats looking to accumulate wealth within a tax-advantaged structure: IUL policies offer market-linked growth potential with a degree of downside protection. However, returns are limited by caps and participation rates, and policy performance depends on the insurer’s long-term crediting decisions.

If you prefer a more stable and predictable policy, alternatives such as whole-life insurance or guaranteed universal life insurance may provide greater certainty but typically offer lower potential returns.

IUL policies are also used by international businesses to insure key executives or partners (“key-person insurance”). This coverage protects the company against the financial impact of losing a critical team member and may also form part of a broader executive compensation or succession plan.

For expats, policy suitability should always be reviewed in the context of residence-based taxation, double-tax agreements, and potential trust or ownership structures that affect cross-border estate planning.