Episode #6: Selecting an Index Crediting Method for Your IUL Policy

One benefit of an IUL is its potential to gain interest based on an external index. But how much indexed interest you receive will vary, depending on several factors. One factor is the interest-crediting method you choose for your IUL. In this episode of Money Script Monday, Sean describes three common crediting methods and shows you how some are more sensitive to volatility or changes in the market index and others offer - but do not guarantee - greater interest potential.


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Video transcription

Hi there. My name is Sean Brady, and welcome to this edition of Money Script Monday. Today, I'm going to be talking about "Selecting an Index Crediting Method for Your IUL Policy".

I know a lot of you viewing already have an IUL and a lot of you viewing are considering an IUL. And today, I'm going to talk about one thing in particular, and that's the index crediting methods.

When you fund an IUL, you have to make several important decisions. One is picking the index option. Whether that's the S&P 500 or some other index, and the other one is the crediting method. That's the interest that's going to be applied, how it's going to be applied to your policy. Now, my goal for you today is to just be better informed when you're making these decisions. And typically, you can make these decisions on an annual basis. So let's just get into it right off the bat.

I'm talking about three things, picking a winner, the various index crediting methods that you'll see across the IUL landscape, and then index allocation diversification.

Picking a "winner"

When you're funding a retirement vehicle, you're going to want that asset to grow as quickly and as much as possible. And what we're seeing in the IUL landscape is a lot of people just picking one particular index option with one particular crediting method.

Picking a Winner

Here's why that can be a problem. When you think about investments, you're not just purchasing one mutual fund, you have a diverse portfolio. It really reminds me of a baseball analogy; it's like having Babe Ruth, the legendary home run hitter for the New York Yankees, having him go up to bat for you every single time. This sounds great, but there's no guarantee that Babe Ruth was going to hit a home run.

In fact, he actually had more strikeouts than he did home runs, 714 home runs versus 1,330 strikeouts. And that's why most baseball teams can't rely on their power hitters for a successful season. They have other players that they can rely on for singles and doubles, and they build a diverse team around their power hitters so they can have a successful season.

Now, with Babe Ruth, your power hitter, when they're not knocking it out of the park, you have those other players whose results are less dramatic, but more consistent and is going to add up time and time again. It's the same thing with Index Universal Life policies. You have your home run hitter type crediting methods over here, but it's not the same. You're going to have them be a little more unpredictable and you're going to want to build a diverse team around them, things like other crediting methods that will give you that consistency and give you a well performing team.

Index crediting methods

These are just some of those that you might see across the IUL landscape, and I want to talk about how these particular methods are related to volatility and their interest potential.

Index Crediting Method

(1) Annual Point-to-Point with Cap & Trigger Method

The lower two are the annual point-to-point with a cap and trigger method, are typically going to be on the low end of the spectrum, in terms of market volatility, and it's also not going to give you the most upside potential as some of these other crediting methods.

Obviously, an annual point-to-point with a cap is going to cap you at something like 12 or maybe 12.5 depending on your policy. Trigger method is sort of unique in which the index crediting method, if it's a negative, you're going to get a zero percent. And if your index option is zero or positive, then you'll get a stated rate, something like 6% or 7%.

(2) Annual Point-to-Point with Participation Rate, Monthly Average with Participation Rate, & Annual Sum

As we move up and towards the middle here, a little more sensitive to the market volatility, but there's also a little more interest potential. Those are your annual point-to-point with participation rates, and monthly average of the participation, and your annual sum. These particular index methods are really meant for stability, and you're probably not going to hit a lot of home runs with these particular options. You're probably going to have a little less strikeouts as well. So you can really rely on these particular guys to limit your options of getting zero percent returns.

(3) Monthly Sum with a Cap

And then finally, we're moving up to the top right hand corner, the monthly sum with a cap. This is the potential to be one of your home run hitters. This is the particular option in which you could get a 15%, maybe 20%, 25% return, and it can be a power hitter for you. But it does come with some risk and unpredictability. If you're in a really volatile market, just one or two bad months could bring the whole percentage down and get you a zero percent credit for that particular year.

Index allocation diversification

It would be great if we could just have one particular index, with one particular crediting method that can hit us home runs consistently, but what we really need is a well diverse team of crediting methods that can perform for you across the board. And that's the great thing about Index Universal Life policies, you have something here that can react positively in just about any market condition.

Index Allocation Diversification

Having a mixture, or a blend, of these types of crediting methods can really help give you a perfect balance of growth potential. So still having the chance for those big return years, and giving you stability, getting that consistent return that's going to time and time, get you on that base.

Now, just a quick recap. We talked about picking a winner, and how selecting just one index option and just one crediting method really can put you on a rocky road to your retirement goals. We talked about the various index crediting methods that you might see you cross the IUL landscape and how they relate to volatility, as well as their interest potential. And then we talked about index allocation diversification and how by doing that, you can combat unpredictability and give you consistent returns.

My challenge to you is go to your annual statements, check out your crediting methods, see how well your IULs have performed, and ask yourself one question...Have you built the diverse team that can perform well for you?

This concludes today's presentation. Thank you for attending Money Script Monday, and we'll see you next time. Take care.

About Sean Brady

Sean Brady is an Advanced Case Designer at LifePro. He works with financial professionals designing advanced case illustrations that are built for longevity and are always in the best interest of the client.