IUL basics
What Is IUL Insurance, and Is It an Investment?
IUL insurance is permanent life insurance with flexible premiums and cash value credited based on a market index. It is insurance, not an investment.
Reviewed by Brian Carrozzi
Founder, RestAssured ยท Licensed life insurance agent
Updated · How we write and review
Short answer: IUL insurance (indexed universal life) is permanent life insurance with flexible premiums, a death benefit and a cash value account. The interest credited to the cash value is linked to a stock market index, within limits the insurance company sets. It is life insurance, not an investment account, and it has costs and risks you should understand before you buy.
What is IUL insurance?
IUL is a type of universal life insurance. FINRA, the regulator that oversees brokerage firms, says “indexed universal life falls under the universal life insurance umbrella” and “follows a set stock index (such as the S&P 500) rather than allowing policyholders to choose their investments.”
It is designed to last for life rather than a set number of years, as long as the policy stays funded. The Texas Department of Insurance (TDI) says universal life “stays in effect until the maturity date, which is usually age 95 or 100,” and that some policies “tie the growth to indexes, such as the S&P 500.”
An IUL has three main parts:
- A death benefit paid to your beneficiary when you die.
- Flexible premiums. You can typically pay more or less, within limits, as long as enough money goes in to keep the policy in force.
- A cash value account that receives part of your premium and pays the policy’s charges.
How does an IUL policy work?
The New York State Department of Financial Services (DFS) explains that universal life treats “premium, death benefit and cash value” separately. Here is the basic flow in most IUL policies:
- You pay a premium. Part of it covers insurance charges and fees. The rest goes to the cash value.
- Charges come out regularly. FINRA says that with universal life, “the cost of your insurance protection and in some cases other costs are deducted from the cash or policy account value.” The cost of insurance charge typically rises as you get older.
- Interest is credited. Depending on your choices, part of the cash value may earn a declared rate and part may earn index-linked credits.
- The policy stays in force as long as the cash value can cover the charges. TDI warns: “If the cash value reaches zero, your policy could lapse.”
How is the interest on an IUL’s cash value figured?
The index-linked credit depends on how the index performed over a set period, adjusted by rules in the policy. The most common ones are:
- Cap: the most interest that can be credited for a period, no matter how much the index rose.
- Participation rate: the share of the index’s gain that is used to figure the credit.
- Floor: the lowest credit for a period, often 0%, so a falling index doesn’t by itself reduce the cash value through a negative credit. Policy charges still come out.
The NAIC’s illustration rules for policies with index-linked credits (Actuarial Guideline 49-A) refer to these same tools: an annual cap, an annual floor and a participation rate. These terms vary by insurance company and product, are set by the insurer, and in most policies can change after you buy. Ask what the guaranteed minimums are.
One more point matters: you don’t own the index or any stocks. The index is only a measuring stick for the credit, and the policy’s rules decide how much of its movement, if any, shows up in your cash value.
Is an IUL an investment?
It’s sold as life insurance, not as an investment account. FINRA describes indexed universal life as “generally not considered a security.” In contrast, it says variable life and variable universal life “are considered securities and must be registered with the SEC.”
TDI says agents who sell variable life insurance in Texas “must have a federal securities license and a state insurance license.” A variable policy’s cash value goes into sub-accounts you choose and can go up or down. An IUL’s cash value is not invested in the market.
An IUL’s main job is the death benefit. The cash value is a feature of the insurance and carries insurance costs.
IUL vs. 401(k): how do they compare?
Some sales pitches present IUL as a retirement plan. They are different products built for different jobs:
- A 401(k) is an employer-sponsored retirement savings plan.
- An IUL is life insurance. Your premium pays for a death benefit, insurance charges and fees, and what’s left builds cash value under the policy’s crediting rules.
Comparing them on “returns” misses the point, because one includes the cost of life insurance and the other doesn’t. Talk with a licensed professional and a tax advisor about your whole situation, including whether you need permanent coverage at all.
Why do some people say IUL is a bad investment?
Most criticism comes from buying an IUL expecting it to act like an investment. The trade-offs are real:
- Costs. Insurance charges and fees come out of the cash value every year.
- Limits on credits. Caps and participation rates limit how much index gain is credited, and they can typically change.
- Lapse risk. DFS says “you will need to actively manage the policy to maintain sufficient funding,” and that “the insurance company can increase mortality and expense charges.”
- Surrender charges. TDI notes “You might have to pay a surrender fee if you withdraw the money early.” These charges are usually highest in the first years.
- Loans and withdrawals. DFS says unpaid loans “will reduce the death benefit” and warns “you may incur a substantial tax bill when you surrender” a policy you’ve borrowed against. TDI adds that “if you withdraw more money than you paid in premiums, you’ll probably have to pay taxes on it.”
- Projections aren’t promises. TDI says the cash value charts agents use “are usually projections and aren’t a promise of a policy’s performance.”
You may also hear “max funded IUL,” which usually means paying more premium than the minimum needed to keep the coverage in force. It still carries all the costs and risks above, and how much you can put in without tax consequences is a question for a tax advisor.
How does IUL compare with other types of life insurance?
| Feature | Term life | Whole life | Guaranteed universal life | Indexed universal life (IUL) |
|---|---|---|---|---|
| How long coverage lasts | A set term | Your lifetime | Typically to a stated age, as long as premiums are paid on time | Until maturity, often age 95 or 100, if the cash value covers charges |
| Premiums | Level for the term in most policies | Fixed | Fixed, and must be paid on time | Flexible, within limits |
| Cash value | Usually none | Yes, builds on a schedule | Little or none in most policies | Yes, with index-linked credits |
| Guarantees | Death benefit during the term | Premium, death benefit and cash values | Death benefit, through a no-lapse guarantee | Limited, such as a minimum floor; most values are not guaranteed |
| Complexity | Low | Moderate | Moderate | High |
TDI describes the no-lapse guarantee behind guaranteed universal life as one that keeps coverage in effect even if premiums don’t cover the cost of insurance, but only if premiums are paid on time. DFS calls term “the least expensive pure life insurance coverage available.” If you mainly need coverage for a set period, such as while you pay off a home, see how mortgage protection compares with term life insurance.
Questions to ask before you buy an IUL
- Can I see the guaranteed and non-guaranteed columns of the illustration? NAIC explains that illustrations show guaranteed elements and “non-guaranteed” counterparts. Ask how the policy performs using only the guaranteed values.
- What are the current cap, participation rate and floor, and can they change? Ask what the guaranteed minimums are.
- What are all the fees and charges? Ask for the cost of insurance and any premium or administrative charges, and how they can change.
- What is the surrender charge schedule? Ask how much you would lose by canceling in each of the first years.
- What happens if I pay less or stop paying premiums? Ask how long the policy would last on guaranteed values.
- How do policy loans and withdrawals work? Ask about the loan interest rate, how loans reduce the death benefit, and what happens to taxes if the policy lapses with a loan outstanding.
- Is the agent licensed, and is this a replacement? TDI says to “make sure the agent and company are licensed,” and warns that replacing a policy “isn’t always a good idea.”
The NAIC Buyer’s Guide also notes that you can usually return a new policy for a full refund within a free-look period, which “usually is stated on the first page of the policy.”
Who might consider an IUL?
IUL typically fits people who want permanent coverage, accept a complex product, and can fund it for many years. If you’re older and mostly want a smaller policy for funeral costs, compare what final expense insurance is instead.
A licensed agent can explain the policy’s guaranteed values, charges and terms for your age and state. Here’s how calling RestAssured works.
RestAssured is a brand of All Phone Leads, Inc. It is not an insurance company or an insurance agency, does not give tax or investment advice, and isn’t affiliated with any government agency. RestAssured connects callers with independently licensed insurance agents.
Frequently asked questions
What does IUL mean?
IUL stands for indexed universal life insurance. It is a type of permanent universal life insurance where the interest credited to the cash value is linked to the performance of a stock market index, such as the S&P 500.
Is an IUL an investment?
It is life insurance, not an investment account. FINRA says indexed universal life is generally not considered a security. Its main purpose is the death benefit, and its cash value depends on the policy’s charges and crediting rules, not on owning stocks.
Is an IUL better than a 401(k)?
They are different things. An IUL is life insurance with insurance charges and a death benefit, while a 401(k) is an employer retirement plan. A licensed professional and a tax advisor can help you decide whether either one fits your situation.
Why do people say IUL is a bad investment?
Most criticism comes from treating IUL like an investment. It has insurance costs, fees and surrender charges, credited interest is limited by caps and other rules, and the policy can lapse if the cash value runs too low.
What happens if I stop paying premiums on an IUL?
The insurance charges keep coming out of the cash value. The Texas Department of Insurance says that if the cash value reaches zero, a universal life policy could lapse.
Sources
- Insurance (life insurance types), FINRA
- Life insurance guide, Texas Department of Insurance
- Types of life insurance policies, New York State Department of Financial Services
- Life insurance illustrations, National Association of Insurance Commissioners
- Life Insurance Buyer's Guide, National Association of Insurance Commissioners
This article is for general education. Policy features, prices and eligibility vary by insurance company and state; your agent will explain the specific terms of any policy before you apply.