Is IUL a Good Investment? What Regulators Want You to Know

Indexed universal life (IUL) is not a good investment if you judge it only as an investment. It is permanent life insurance with a cash value account, and the costs of that insurance, plus caps on how much interest you can earn, mean it usually grows more slowly than money invested directly. It can be a good fit when you need a lifelong death benefit and want some cash value on the side.

Regulators' warnings point the same way. The rest of this guide explains why, what they warn about, and who an IUL may suit.

Is IUL an investment or insurance?

IUL is insurance. Its cash value earns interest linked to a stock index, but you don't own the index or any securities.

FINRA explains that indexed universal life "is generally not considered a security," while variable life and variable universal life are securities that must be registered with the SEC. IUL follows a set index, such as the S&P 500, "rather than allowing policyholders to choose their investments." Because it is insurance, your state insurance department regulates it.

That matters in two ways. First, you are paying for a death benefit, so part of each premium never reaches your cash value. Second, the person selling it may hold only an insurance license, not a securities license. The NAIC notes that your state department of insurance lists the agents and companies licensed in your state.

Why does IUL usually grow more slowly than the market?

Because your interest is limited on the way up and your policy charges come out every month.

The SEC's bulletin on indexed annuities, which use the same kinds of crediting methods, describes the limits:

• Rate cap. The most you can be credited. The SEC's example: with a 7% cap and a 12% index return, only 7% is credited.
• Participation rate. The share of the gain you get. At 75%, a 10% index return credits 7.5%.
• No dividends. Index gains are generally calculated without dividends paid on the stocks in the index.
• Changeable terms. Contracts "commonly allow the insurance company to change some of these features periodically, such as the rate cap."

On top of that, every month the policy deducts the cost of insurance and other charges from your cash value. A 0% floor means a bad index year credits nothing, but those charges still come out, so your balance can go down. For worked examples, see how IUL caps and participation rates work.

What do regulators warn about with IUL and universal life?

State regulators have warned that universal life policies can cost more than expected and lapse with little value left.

In a 2019 consumer alert, the New York Department of Financial Services said it had received a higher than average number of complaints about universal life policies. It warned that:

• Internal charges "can increase every year."
• Most universal life policies "do not provide long-term guarantees of premium payments, cash value or benefits."
• Premium amounts are often set on assumptions about future interest rates or market performance, and if actual earnings come in lower, you may have to pay more.
• Many owners who paid for years found their policies "had lapsed and had little to no value."

DFS's acting superintendent put it plainly: "if you don't understand the policy, don't buy it." The Texas Department of Insurance adds that when premiums fall short of the cost of insurance, the difference comes from cash value, and if cash value reaches zero, the policy could lapse.

Can you trust an IUL illustration?

Only the guaranteed part. Everything else is a projection based on assumptions that can change.

The NAIC's illustration rules require a basic illustration to show both guaranteed and non-guaranteed elements. For index-linked policies, the NAIC adopted Actuarial Guideline 49, later replaced for newer policies by AG 49-A, to make illustrations more uniform and easier to compare.

When you review one, ask for:

1. The guaranteed column, showing what happens at minimum crediting and maximum charges.
2. A run at a lower crediting rate than the one the agent highlights.
3. The premium needed to keep the policy in force to age 100 under the lower rate.
4. The surrender value, not just the account value, for each of the first 10 years.
5. What happens to the death benefit if you take policy loans for income.

If the policy only works at the highest illustrated rate, it's underfunded for real life.

Who might an IUL actually fit?

An IUL may fit someone who needs life insurance for life, has already used lower-cost savings options, and can pay well above the minimum premium for decades.

It is more likely to fit if you:

• Need a death benefit that lasts past your working years, such as for a spouse, a dependent with special needs or estate costs
• Already capture any employer 401(k) match and contribute to IRAs; see IUL vs. 401(k)
• Earn too much to contribute directly to a Roth IRA; see IUL vs. Roth IRA
• Have steady income and an emergency fund, so you won't need to stop premiums
• Will read your annual statement and request an in-force illustration every year

It is less likely to fit if you:

• Mainly need coverage while your kids are young or your mortgage is unpaid; term usually costs far less, see IUL vs. term life insurance
• Want the highest long-term growth and are comfortable with market swings
• Might need the money in the next 10 years
• Are being told to stop saving in a 401(k) to fund the policy

What should you do before buying an IUL?

Slow down, get documents in writing and compare at least one alternative.

1. Check the seller. Confirm the agent's license with your state insurance department. If they also sell securities, FINRA says they must be registered, which you can check on BrokerCheck.
2. Ask what isn't guaranteed. The NAIC suggests asking what part of the premium or policy value isn't guaranteed and whether there are guaranteed minimums.
3. Compare to term. Ask for a term quote for the same death benefit so you can see how much of the IUL premium is going toward cash value and costs.
4. Use your free look. New York gives at least 10 days after delivery to cancel for a full refund, and the Texas Department of Insurance says Texas policies allow at least 10 to 20 days. Check your own state's rule.
5. Review every year. Texas says the company will send a yearly report showing your cash value and how long the policy might last, and New York law allows one free in-force illustration per year. If the projection slips, you may need to pay more.

For the full list of trade-offs, see IUL pros and cons, or browse all our IUL guides.