Indexed Universal Life Insurance (IUL), Explained

Table of Contents

What Is Indexed Universal Life (IUL) Insurance?
Why Someone Would Pick Indexed Universal Life Insurance
Drawbacks of Indexed Universal Life Insurance
How IUL Insurance Works
Indexed Universal Life Insurance vs. Other Life Insurance Policies
Is an IUL Better Than a 401(k)?
Frequently Asked Questions

Life insurance is on the same list with water or oxygen or champagne—essentials everyone needs. (Or sparkling apple cider if you prefer the mocktail version.) But there’s one kind of coverage being served up over the past few years that nobody should cheers. It’s called indexed universal life insurance.

IUL is a rip-off that tries to use a slick package to bundle life insurance with a lousy investment product. It’s like slapping a Dom Perignon label onto a bottle of Miller High Life. Sound too bad to be true? It’s very real, and it’s worse than a hangover.

Let’s find out why!

Indexed universal life (IUL) insurance uses your premiums to pay for two features:

• A life insurance payout for your family or estate
• A cash value account tied to an index fund (that’s why it’s called indexed)

So, that’s the definition. But here’s the deal: Insurance is not an investment. And anytime you see an insurance product that also tries to be a savings or investment account? Huge red flag.

With an IUL, the amount of your premium isn’t fixed—and it’ll rise as you age. (Sorry to be the bearer of bad news, but older people have a higher chance of death.) That means you run the risk of having the life insurance policy lapse if the premiums get too high to be covered by your cash value or other savings. Yikes.

That’s how IULs work, and that’s why they’re a terrible way to take care of retirement planning or life insurance. Stay far, far way.

If you’re planning to retire and you love your family—and I’m pretty sure that’s your vibe—combining savings and a death benefit in an IUL might sound like a win-win. I get the thought process! But think about this—while a few of the features in an IUL seem appealing, there are really more catches here than in a game of Pokémon Go.

Let’s start with a look at the benefits:

• It includes a cash value account that can grow through modest returns based on how well a certain index fund does, which I’ll talk about more later. (But for now, just know there are many better ways to save and invest.)
• Any investment growth in your IUL is tax-free. (But the same goes for many kinds of retirement accounts.)
• The death benefit is in force (aka active) permanently—as long as you keep up with the premiums. (But if you’re staying out of debt and building wealth with the Baby Steps, you’ll eventually become self-insured.)
• Sometimes an IUL includes a minimum guaranteed rate of return. (But even if it does, it’s unlikely to get you as much cash as you’d get from investing in growth stock mutual funds.)

There are plenty of problems here:

• The investments in an IUL never perform like they should because the cash portion of the premium gets eaten up with fees the insurance company takes for managing the investment.
• Those aren’t the only fees you’ll face with an IUL: commissions for the sale, administrative expenses, premium expense charges and the surrender charge—yeah, there’s a charge for ending the policy. You’ll see these fees a lot with most kinds of universal life coverage.
• When you cancel an IUL policy, you give up two huge things—your death benefit and, even worse, most or all of the cash value you’ve managed to build. Whoops! Makes you wonder what exactly you were getting for all those high premiums.
• Because the pesky fees keep returns pretty low, your IUL investment will never beat inflation, which is one of the main goals of investing. Let’s not go there. You’re far more likely to stay ahead of inflation by investing in mutual funds through a Roth IRA or 401(k). You’ll like the 10–12% average annual return way better than breaking even. Investing in anything that can’t keep up with inflation is a waste of your money.
• Market performance will affect your premiums, which might rise or fall depending on how well the index fund tied to your account does. But premiums can definitely rise in a down period. And remember what we discussed about unaffordable premiums? You’ll risk losing the life insurance coverage that was supposed to be the whole point of buying the policy! It’s like signing a prenup that lets your spouse ditch you if your portfolio dips—a crappy deal all around.

Again, an IUL tries to solve two unrelated financial issues and is no good at solving either. What’s the real point of combining insurance with investing as a single product? If you said, “helping insurance companies make money,” give yourself a high five (and a swig of champagne). The bottom line is, having the two services wrapped together winds up making the insurance portion very expensive, especially compared to what you’d pay for term life coverage.

Compare Term Life Insurance Quotes 

Don’t get me wrong. I love life insurance—specifically level term life insurance—because it’s the absolute smartest way to guarantee your loved ones will be well provided for if anything ever happens to you.

But not all life insurances are created equal, and I’d never recommend any form of whole life or universal life insurance. It’s a bad deal for you every time.

IUL puts a new spin on that bad deal. It’s sold as a flexible plan that lets you set your own premiums and put money into a savings account tied to a little something known as an index fund. I mentioned index funds up top, so let’s talk a little more about what they are.

Even if you’re an investing rookie (we all start somewhere), you’ve probably heard of the stock market. (I’m a big stock market fan, and it’s something I recommend people invest in, but only in the right ways.) You’ve probably also heard of some of the popular indexes like the Dow Jones Industrial Average and the S&P 500. You’ve also heard of the Indy 500. No relation there, sadly. The first two are indexes that measure how well the market (or a specific part of the market) is doing.

Index funds invest in the companies that are included in a specific index. So, you can invest in an S&P 500 index fund, for example, which mirrors the performance of the largest 500 companies in the U.S. Some investors like to use them as a passive form of investing that typically gives them average returns on their investment.

The question is, how do index funds tie in with an IUL? Let’s break it down. I’ve already mentioned an indexed universal life insurance plan has both a life insurance portion with a death benefit and a cash value portion. Well, an IUL ties the cash portion to one of these index funds.

And as long as the market does well, the cash value will go up. In theory, it could grow enough to allow you to pay lower premiums as you age because you’re allowed to cover some (or all) of your premiums through the cash value of your IUL policy! Doesn’t it sound great?

But there’s a catch—and there always is with any permanent insurance tied with investment. The catch is that in an IUL, your return on investment (ROI) will always be slightly below the performance of the index. Why?

Because, as I already mentioned, the insurance company will hit you up hard for fees. Lots of fees. With these fees, it’s very hard for your cash value to grow fast or large enough to even offset inflation, let alone help you cover premiums.

And about those premiums. I should remind you that insuring your life becomes more expensive as you age. So, if your cash value is only holding steady over time, or even dipping when the market dips, but your premiums keep rising . . . do you see a problem developing? Yeah. Keeping your policy in force is going to become very expensive—and it could even wipe out anything you’ve saved in the cash value. This IUL thing is a major rip-off!

To sum it up, the main problem with IULs (and any other permanent life insurance, for that matter) is that two good intentions—life insurance and investing—wind up canceling each other out.

Compare this with term life insurance, which is designed to keep coverage simple. Based on your age, term life companies look ahead 15 or 20 years and figure out the average price to insure you throughout the term.

It’s way cheaper than what you’d get with any form of permanent coverage. And the price is locked in throughout the life of the policy. No fluctuating premiums, and no worries about a bad stock performance wiping out your policy. Doesn’t that sound like a much smarter way to be sure your family is covered? (That’s rhetorical. It is!)

The terms whole life or universal life give us another clue about how these products work. They’re designed to last your whole life, all the way into your ’90s and beyond. I don’t know about you, but I like options—and I don’t love buying products designed to control me for 50 years or more.

Here’s the thing these policies overlook: the Baby Steps. Like I said before, if you’re working that plan, you’ll have so much money in your nest egg that you won’t even need an ongoing life insurance policy. You’ll be self-insured!

I think it’s pretty clear already that an IUL isn’t your best bet for life insurance. But let’s compare it directly with a few other kinds.

IUL vs. Term Life

The real purpose of life insurance is to guarantee that when you’re young and healthy with people depending on your income, they’ll be okay even if something bad happens to you. An IUL doesn’t deliver on that need and also lasts way too long. But a 15- or 20-year term life policy takes care of it at a fair price—and only while you need it.

Buying a term life policy when you’re young is smart and affordable. You can figure out the term based on how long you expect to support anyone who depends on your income. Let’s say you’re planning to start a family soon. (P.S. If you need a solid boy name, George is back in style.) A 20-year term life policy might make sense for you. Or maybe you already have a toddler or two on your hands (thoughts and prayers for you). In that case, a 15-year term life policy might make more sense and would have a lower premium than a 20-year policy.

Whatever your situation, set coverage up to last only as long as your kids are under your roof. Once they’re on their own, you can drop the premiums and put the savings toward your tax-advantaged retirement accounts.

If you’re married, then both you and your spouse need term life policies. Each policy should be worth 10–12 times your annual income (stay-at-home parents need coverage too).

And if you already have IUL (or some other kind of whole life or universal coverage)? Yes, you’ll want to drop it—but be sure to get term life coverage in place and active before canceling any existing policies. That current policy is better than nothing, and you never want even a brief gap in coverage for life insurance.

IUL vs. Whole Life

Let’s start with the obvious: IUL and whole life are both forms of permanent life insurance. So, I’m not a fan of either kind really. But some IULs will have a guaranteed minimum interest rate. That means it’s possible you’ll see a bit better returns on your cash value with an IUL than with whole life. Overall, it’s like comparing Peloton versus NordicTrack: There are differences, but you’re getting a similar product either way.

IUL vs. Variable Life

Next, let’s compare IUL and variable life. Once again, we’re talking about two different forms of permanent life insurance—otherwise known as two flavors of something gross (like those congealed salads your Aunt Donna brings to Thanksgiving every year).

Unlike an IUL, a variable life policy lets you pick from a variety of investment options to put your cash value into. Big whoop. It still messes with your life insurance, and it doesn’t compare as an investment to good old mutual funds. Hard pass.

Credit card versus debit card—is one superior? To ask is to answer. But just in case it’s not obvious yet, credit cards are dumb, and an IUL is totally inferior to a 401(k)—or any kind of tax-advantaged retirement account that invests in growth stock mutual funds. Stick to your 401(k).

Building Wealth With IULs

An IUL is a terrible wealth-building tool. To repeat, it ties your cash value to an index fund. This is an extremely overrated strategy to grow money. And the only ones who will tell you otherwise are the slimy life insurance salespeople selling it.

If the problems with IUL investing still aren’t clear, think about how the insurance company will pay out interest. Index funds are paid out by taking the average of the returns from a large group of funds. We emphasize average because in the investment game, you want better than average. So, while index funds generally trend up over the long term, they’re also less flexible than investments that let you choose from among many good growth stock mutual funds—our top choice for long-term wealth building.

Plus, since this is an investment, it’s subject to the same risk all investments share—you could lose money. With an IUL, your cash value could shrink or disappear completely if the IUL doesn’t have a guaranteed minimum rate of return. That sucks. This is why I’m telling you an IUL does a terrible job at being both a death benefit and investment opportunity.

To recap on IULs, you’re looking at a sucky form of investment that doesn’t give you much buying flexibility or above-average rates of return. Not to mention, all the insurance fees end up devouring the already unimpressive cash value growth. Even that Miller High Life is starting to look good.

The Truth About IULs

Above all, life insurance has one job: to replace your income when you die. That’s it. IUL might do that, but it might also rob you blind before you ever see the benefits pay out. Life insurance is there to provide for your loved ones, not make them rich. Maybe you’re thinking, Yeah, IUL does sound like a big mess—but I’m still not completely sure what to do next.

Let me give you some next steps toward getting the best coverage possible for you and your family.