IUL pros and cons: indexed universal life insurance explained

How an IUL works, in a few words

You pay a premium. The insurance company deducts the cost of insurance and other charges, and what is left builds the cash value. Each period, that value receives interest calculated based on how the index moved, with a maximum limit (cap), a participation rate and a floor, which is usually 0%.

You do not choose stock market investments: the index is only used to calculate the interest. So if the index goes up a lot, you receive up to the cap; and if it goes down, the floor keeps that period from crediting you negative interest.

The pros of IUL

When it is well designed and well funded, these are its advantages:

• A protective floor: when the index falls, the credited interest does not go below 0% (or the contract’s floor). The NAIC’s AG 49-A uses a 0% floor in its benchmark account.
• It can credit more interest than the fixed account in periods when the index rises, up to the cap; this is not guaranteed.
• Flexible premiums: you can adjust how much and when you pay, as long as the policy has enough value to cover its charges.
• Loans against the cash value, as a right under the contract; as long as the policy is not a MEC and stays in force, they are generally not taxable (section 72(e)).
• Lifelong protection: the death benefit is generally not taxable income for your family.
• Some policies include living benefits for critical, chronic or terminal illness; it depends on the insurance company and the state.

The cons of IUL

These are the ones you need to understand before you sign:

• The cap and participation rate are not guaranteed: the insurance company can change them within the contract’s minimums, as IUL illustrations filed with the NAIC show. The NAIC’s Model Regulation 582 prohibits presenting these elements as guaranteed.
• Charges do not stop: even if the index credits 0%, policy charges and the cost of insurance keep being deducted, so the cash value can go down.
• The cost of insurance rises with age: the Wisconsin Office of the Commissioner of Insurance warned that, in universal life, that cost increases over the years and that some policies lapsed.
• Risk of lapse: if you pay only the minimum or take large loans, the value may fall short and you would have to pay more to keep the policy.
• It is complex: FINRA explains that insurance products can be complex and carry charges. You need to read the full illustration.
• Surrender charges: if you cancel in the first years, you may get back much less than you paid.

An illustration is not a promise. Since 2020, the NAIC’s Actuarial Guideline 49-A limits the rate that can be illustrated and requires showing a lower alternate scale. Ask to see both scenarios.

How to read an IUL illustration without getting confused

Look at these points:

• Guaranteed vs. non-guaranteed column: the guaranteed column shows what happens at the contract’s guaranteed rates and charges. That is where you see in what year the policy could lapse if everything goes wrong.
• Illustrated rate: compare it with the alternate scale that AG 49-A requires.
• Illustrated loans: if the illustration shows loans for retirement, check what happens in the low scenario.
• Required premium: ask how much you need to pay for the policy to last to age 100 or beyond in the conservative scenario.

Who does an IUL make sense for?

It usually makes sense for people who need permanent life insurance, have a stable income, can pay more than the minimum for many years and want a cash value with a protective floor. Also for people who already contribute to their retirement plan at work and want an additional source of money while they are alive.

It is usually not a good fit for people who only need temporary protection at the lowest cost, for people who cannot pay consistently, or for people who would buy it instead of taking advantage of their employer’s 401(k) match.

Frequently asked questions