How IUL caps and floors work

Indexed universal life, or IUL, is a type of permanent life insurance with cash value. The interest on that cash value is tied to a market index, such as the S&P 500.

IUL caps and floors shape that interest more than anything else. Here's how they work, using simple examples.

How index crediting works

With an IUL, you don't pick investments, and your cash value is not invested directly in the stock market. Instead, the insurer looks at how an index moved over a set period.

Based on that change, the policy credits interest to the part of your cash value placed in an indexed account. Insurers use different methods to measure the change, such as annual point-to-point or averaging.

How IUL caps and floors work

The cap

The cap is the most interest your indexed account can be credited for that period. It puts a ceiling on the upside.

For example, if the cap were 9% and the index rose 15%, you would be credited 9%. If the index rose 6%, you would be credited 6%.

Caps are not locked in forever. The insurer can change the cap while the policy is in force.

The participation rate also matters. It's the share of the index gain used to figure your credit, so a rate below 100% lowers what you receive.

For example, at an 80% participation rate, a 10% index gain would count as 8%, still subject to the cap. Our post on what a participation rate means goes deeper.

The floor

The floor is the lowest rate the indexed account can be credited. It's often set at 0%.

For example, if the index fell 12% in a year, a 0% floor means your index crediting for that period would be 0% instead of a loss. That's the main appeal of IUL for many families.

But the floor applies to index crediting only. Your policy still has costs taken out of the cash value, even in a year with 0% crediting:

• Cost of insurance charges
• Policy fees and expense charges

So in a flat year, your cash value can still go down. These costs can also rise over time.

Why funding still matters

An IUL is flexible. You can often change how much you pay, as long as you pay enough to keep the policy in force.

If you pay too little, or crediting is lower than expected, charges can draw down the cash value. If it can't cover the policy's costs, the policy can lapse unless you pay more or lower the death benefit.

That's why it helps to review your statements regularly and ask for updated illustrations. Our list of questions to ask before buying an IUL can help.

You can learn more about this coverage on our indexed universal life page.

Common questions

Can you lose money in an IUL?

The floor can keep index crediting from going below a set level, often 0%. But fees and cost of insurance can still reduce your cash value, and an underfunded policy can lapse.

Can the insurance company change my IUL cap rate?

Yes, caps can usually be changed while the policy is in force, within the limits in your contract. It's worth checking your current cap each year.

Bottom line

Caps limit how much index interest you can earn, and floors limit index crediting losses. Together, they shape a range of possible results.

Still, the floor does not protect your cash value from fees and cost of insurance. A well-funded, regularly reviewed policy gives you a better chance of keeping coverage in force.

Have questions about your situation? Book a complimentary call with our team.

This article is for general education only and isn't financial, tax or legal advice. Product features vary by carrier and state. Talk with a licensed professional about your situation.