When Does an Indexed Universal Life Policy Actually Make Sense?

Indexed universal life insurance has become one of the most heavily marketed—and heavily criticized—products in financial services.

Depending upon who you ask, an IUL is either an extraordinary financial tool or something nobody should ever own.

Both positions are too simplistic.

Indexed universal life insurance is a tool.

The question is whether the client's problem actually requires that tool.

First: What Is an IUL?

Indexed universal life is permanent life insurance.

Like other universal-life policies, it combines a death benefit with a cash-value component. The NAIC classifies universal life among cash-value forms of permanent insurance. NAIC

With an IUL, interest credited to certain policy values can be linked to an external market index according to the insurer's contractual crediting methodology.

That does not mean the policyowner directly owns the stocks in the index.

Returns are governed by the policy.

Depending upon the contract, variables may include:

• participation rates,
• caps,
• spreads,
• floors,
• policy charges,
• cost of insurance,
• premiums,
• withdrawals,
• loans,
• and crediting methods.

That distinction is enormously important.

When We Believe IUL Deserves Consideration

1. There is a genuine permanent death-benefit need

This comes first.

If someone needs $1 million of protection for twenty years, inexpensive term insurance may solve that liability exceptionally well.

Using a complicated permanent policy merely because it has additional financial features can amount to solving the wrong problem.

An IUL becomes more interesting when the client has a legitimate reason for maintaining life insurance over a much longer period.

2. The client has strong cash flow

Permanent insurance is usually a long-term commitment.

That matters because a sophisticated policy can become a poor financial decision if it is funded for three years and abandoned in year four.

Before considering significant permanent premiums, a household should generally understand the more fundamental pieces of its financial position:

• cash reserves,
• household debt,
• insurance needs,
• retirement savings,
• short-term liquidity,
• and foreseeable obligations.

Buying an advanced product while basic financial vulnerabilities remain unaddressed is usually poor sequencing.

3. Traditional retirement strategies are already being utilized appropriately

This is where we tend to become skeptical of aggressive IUL marketing.

If someone is barely contributing to an employer retirement plan, has no emergency fund and carries high-interest debt, presenting a large IUL as their primary “retirement strategy” deserves scrutiny.

For some higher-income clients, however, the conversation may look different.

The client may already be:

• contributing significantly to retirement plans,
• accumulating investments elsewhere,
• maintaining strong liquidity,
• and seeking additional long-duration planning options.

At that point, permanent insurance may deserve evaluation within the overall strategy.

4. The client understands that illustrations are not guarantees

This is critical.

A life insurance illustration shows how a policy may perform under stated assumptions.

It is not a promise that nonguaranteed values will materialize exactly as shown.

A responsible analysis should examine more than the attractive middle column.

Ask:

What is guaranteed?

What is not?

What happens at lower crediting assumptions?

What happens if premiums are reduced?

What happens if policy charges change within contractual limits?

What happens if loans are taken?

What happens during extended periods of weak performance?

What keeps the policy in force?

If the strategy works only under optimistic assumptions, that should be understood before—not after—the policy is purchased.

When IUL Often Does Not Make Sense

“I want something better than my 401(k).”

That statement alone is not a planning objective.

Life insurance and qualified retirement accounts have different purposes, structures, tax rules, costs and risks.

Comparing them solely using an illustrated accumulation value can obscure more than it reveals.

“I don't want to lose money in the stock market.”

An IUL can limit exposure to direct negative index crediting within applicable account mechanics, but that does not mean policy values cannot decline.

Insurance costs and other charges still exist.

A 0% index crediting result is not necessarily the same thing as a 0% change in total policy cash value.

“My agent says I can borrow money tax-free forever.”

Policy loans require more careful language than that.

Loans and withdrawals can reduce policy values and death benefits and may create serious consequences if a heavily funded or heavily loaned contract lapses or is surrendered.

Federal tax treatment of life insurance is complex and depends upon policy structure and circumstances. Surrender proceeds above the owner's investment in the contract can generally create taxable income. IRS

Anyone considering insurance substantially for tax-related reasons should coordinate with appropriate tax professionals.

“The illustration shows 7%, so that's what I'm earning.”

No.

An illustrated nonguaranteed crediting assumption is not equivalent to an investment-account return guarantee.

The policy's actual performance depends upon the contract and future experience.

Design Matters as Much as Product Selection

Two IUL policies from the same carrier can potentially behave differently depending upon how they are designed and funded.

Factors can include:

• death-benefit configuration,
• premium level,
• funding duration,
• policy charges,
• rider selection,
• distributions,
• loans,
• and ongoing monitoring.

That makes IUL particularly poorly suited to transactional selling.

A complex long-term product should receive complex long-term servicing.

If the advisor never intends to review the policy after it is issued, that should concern the client.

IUL Isn't “Good” or “Bad”

The better framework is:

What problem are we solving?

If the objective is simply:

Protect my young family for the next twenty years at the lowest practical premium.

Term insurance may be difficult to beat.

If the client has:

• substantial cash flow,
• an identified permanent death-benefit need,
• a strong existing financial foundation,
• long time horizons,
• and additional planning objectives,

then an IUL may deserve analysis alongside other potential solutions.

That is very different from declaring that everyone should own one.

We are skeptical of any financial professional whose answer is always the same product.

Good planning should produce different recommendations for different people.