Indexed Universal Life Insurance (IULs): What To Know

Indexed Universal Life Insurance, or an IUL, is a hybrid insurance product that seeks to combine the benefits of life insurance and investing.

As with any financial product, for certain people, a cash value life insurance policy could make financial sense.

However, the glitz and glam associated with IULs make it easy to get sucked in without having real knowledge of the product. These products are often promoted on social media as “safer” or “better” alternatives to investing for retirement, saving for college, and more – when the reality could be misleading.

Here’s what you need to know about Indexed Universal Life Insurance (IULs), and whether they are right for you – especially when compared to traditional retirement vehicles like a Roth IRA or 401k.

What Is Indexed Universal Life Insurance?

IULs are complex insurance products that combine life insurance with some type of investment product, guarantees, costs, and rules.

With these insurance policies, your growth of the cash value is typically tied to the performance of some underlying index. In the case of many IULs, the value depends on the S&P 500 returns.

IULs are usually designed to offer regular income during retirement. During retirement, the investment owner will draw down from the cash value to cover living expenses. However, the remainder of the investment will stay invested and be used to fund the life insurance premiums and expenses.

How It Works

You pay premiums. A portion covers the cost of insurance and policy fees. The rest goes into the cash value account. The cash value earns interest based on index performance.

• Cap rate: the maximum credited return (e.g., 10%).
• Participation rate: the percentage of index gain you get (e.g., 70%).
• Floor: the guaranteed minimum return (often 0%).

Example: If the S&P 500 rises 10%, and your policy has a 70% participation rate with a 9% cap, you’d earn 7%. If the market falls 10%, you’d earn 0%.

You can access the cash value, but there are limits. Through policy loans or withdrawals, you can tap into the cash value tax-deferred — though unpaid loans reduce your death benefit.

When you pass away, your beneficiaries receive the death benefit, minus any outstanding loans. You don’t get the cash value back.

The Basics Of IULs

Before we continue on, it’s important to understand some of the basics of IULs. Here’s some of the common terms and functions of an indexed universal life insurance policy. It’s easier to think of an IUL as a vehicle, and all of these moving parts are within the vehicle. 

Life Insurance Policy –  Let’s start with the basics. As an IUL is a life insurance vehicle, one of the main components of the vehicle is a life insurance policy. This life insurance policy must be paid with premiums – just like any other life insurance policy. Depending on the policy, these premiums may increase every year. The goal is that the entire IUL can self fund the premiums over time using the cash value, but that may not happen for years, if ever. Also, it is life insurance, so you need to pass a physical to get insured, and your premium rate will depend on how healthy you are. Younger, healthier people will pay less for their policy. 

Cash Value – As this sounds, this is the amount of cash available in the account. This is basically the amount of money you have if you walk away and cancel the plan.

Account Value – This is the value in your account which is “growing” through dividend credits. This is also the amount used to pay fees, premiums, and more.

Surrender Fees – If you cancel the plan early, you can expect to pay surrender fees. Depending on the plan, this could be a significant fee. A common fee structure is 10% in year one and decreasing 1% per year – so in year 10 there is no fee. Some plans push the surrender charge out 14 years or more.

Dividend Credit – This is how much gets credited to your account each year based on the performance of the underlying index and the terms of your contract (participation rate and cap and floor – see below). It’s not actually the return of the stock market! It’s a number designated by your insurance company based on the terms of your agreement.

Inside your IUL you don’t actually invest in anything – it’s still an insurance contract. And each year the insurance company credits you a dividend to your cash value based on the rules of the agreement. 

Participation Rate – That participation rate is how much of an index you get to participate in the gains and losses of. For example, let’s use an IUL that uses the S&P 500. A 100% participation rate means if the S&P 500 is up 10%, you’re credited 10%. A participation rate of 80% means if the S&P500 is up 10%, you’re up 8%. Typical IULs have participation rates from 50% to 150%.

Cap and Floor – This is the maximum and minimum amount of the index you’ll get. If there is a cap of 10%, even if the S&P500 goes up 20%, the most you’ll get is 10%. Many IULs also advertise a floor of 0%. Meaning if the S&P500 is ever negative, you simply stay at 0%. Remember, the 0% floor doesn’t mean you can’t lose money, it just means you don’t get a dividend credit that year. You’ll still need to pay your premiums and fees.

This is one of the main reasons that IUL promoters say these products have no downside risk.

Loans – IULs can offer loans against the cash value in your account. This loan has an interest rate, which can vary by plan. You can use this loan to access the cash value of your account tax-free. The interest rate is also typically variable, and can rise.

Policy Lapse – A policy lapses, or is voided, when the cash value is $0 and a premium payment or fee cannot be paid. You can prevent a policy lapse by paying your own money into the plan (which is what you do up front – or maybe even spread it over several years), or by self funding. Most insurance agents would tell you the goal is to self fund – get a big enough premium in so the cash value grows faster than the premiums due. They typically will encourage you to highly fund an IUL in the first 2-5 years to get to this point of self-funding.

Advertised Benefits

A lot of marketing material for IULs stress that its features and benefits are slightly different than any current life insurance or annuity products on the market today. Many promoters on social media will even says that it’s a better option than putting your money in a Roth, Traditional IRA, or 401(k).

First, many IUL plans have a 0% floor. In other words, your investments will never have a negative return. However, it’s important to note that even with the 0% floor, you could still lose money on an IUL once premiums, fees, and any loan interest cost have been taken into account. 

Second, IULs have no age restrictions or early withdrawal penalties (compared to accounts like a Roth IRA). Promoters of these products will say this make them a great option for early retirees. However, to access your cash you’re doing so through a loan – so while there are no age restrictions, there is a loan involved. The reason is you can’t withdraw more cash than your basis or you will face taxes.

Furthermore, cash withdrawals diminish the value and reduce “compounding” or future credits. So most would recommend a loan anyway.

Costs And Risks

Insurance costs inside an IUL are “front-loaded,” meaning that they are very high for the first several years of the policy. If you decide the IUL is not for you, you will very likely get less money out than you put in. In investing terms, you’re likely to face negative returns over the short-term. 

The risk of policy lapse is high in the first few years, especially if you don’t fund a large enough premium up front. And if the policy lapses, you basically threw away all your money. 

The risk of policy lapse can also be high if your insurance premiums rise (especially as you get older). Since the insurance inside your IUL is a renewable term policy, you’re faced with term renewals and associated premium increases every year or two. When you’re young and healthy, this doesn’t really matter. But as you age, the premium prices can rise dramatically.

If you combine this with the potential of low growth, your policy may not be able to self-fund the premiums.

Here’s a great article breaking down the math on IULs and where these dividend and return credits pose problems.

Are IULs Retirement Accounts?

Given the cost of an IUL, many people will have to choose between retirement investing and IUL. The cost of IULs are so high (if you want them to work out in the long run) that most people will have little money left over for traditional investing.
Most insurance salespeople will justify this cost by positioning the IUL as a form of retirement investment. It’s not. An IUL is a form of life insurance. As with all whole life insurance contracts, retirees can borrow against the cash balance to fund their retirement.

And, yes, cash value life insurance withdrawals are typically tax-free up to your basis. And yes, you can access your cash before retirement age with a loan… but none of these features make it a retirement account or better than a retirement account.
This financial product could work for you, or it could not. But it should be very clear that the IUL is not a retirement account. It’s a cash value life insurance plan. 

Just look at this message from NASCAR Driver Kyle Bush, who allegedly lost over $8 million due to mis-sold IULs:

Are IULs A Good Place To Invest?

Frankly, no. An IUL is not a particularly good place to put retirement funds. Many social media videos will have you believing that IULs have unique tax advantages that can’t be replicated elsewhere. In reality, qualified retirement accounts like Roth IRAs and 401(k)s tend to offer superior tax benefits.

For the same amount of money, you could just purchase the S&P500 index yourself in a retirement account and enjoyed better risk-adjusted returns.

If you’re looking to fund your retirement, the common wisdom is to invest money through an employer-sponsored retirement plan if you have a match available to you. If you’re a freelancer or small business owner, you may want to consider a Solo 401(k) or one of the other self-employed retirement plans. And Traditional or Roth IRAs are usually the best options for everyone else.

People who don’t want to invest in the stock market should look at real estate or small business investments. But a life insurance contract should not be the first place you look to invest for retirement.
Anyone seriously considering a life insurance or annuity product for investing should consult with a fiduciary financial planner (perhaps one specializing in estate planning) before buying the contract. If this product doesn’t fit your needs, it can end up being a very expensive mistake.

When Could An IUL Policy Make Sense?

There are honestly very few cases where we believe an IUL is the right financial tool for the job. We try not to dismiss every financial product even if it doesn’t seem like a fit for the broad market. So, when does an IUL make sense?

Well, potentially for ultra high net worth individuals who are maxed on all their traditional tax-deferred means, and are looking for some downside protection (maybe due to other high risk assets in their portfolio), and don’t mind paying the premiums associated with that protection. Whew… that’s a lot. And chances are, that’s not you. 

Be Careful With Mixing Insurance And Investing

If you’re reading this, please just be careful mixing insurance and investing. When you combine the two, you typically get less insurance at a higher cost, and your investments underperform traditional accounts (due to those caps).

Furthermore, the incentives of most insurance salesmen don’t always align with your own personal financial security. While researching this article, we came across this in an insurance agent board:

In some cases, these IUL plans may not be setup for your best interest, but potentially the agent’s best interest (by earning them a big commission check). And the language and terms can be confusing, so it makes sense you might not know if this plan or policy is best for you.

Final Thoughts

Let’s be clear – IULs (Indexed Universal Life Insurance) are not a scam. But we also think most insurance agents (especially those you see on social media) are NOT transparent about what it is, how it specifically works, and the exact risks or scenarios where it could fail you.

We want community members to understand how investment products work so they can make informed decisions about what should belong in their portfolios. Don’t just watch a TikTok or Instagram Reel about this financial product (or any financial product) and think it will be the right fit for you. Do your homework, and understand why you’re getting it.

If you’re just getting started with investing, we have in-college and after-college guides that can help you maximize returns and avoid the biggest investing pitfalls. Or, if you’re specifically looking to invest for retirement, you may want to check out The Best Order Of Operations For Retirement Savings.