Is IUL a Good Investment? When It's Worth It and When It's Not

Is IUL a good investment? I get that question more than almost any other, usually right after somebody watched a video calling it the best thing ever sold or the worst. So hit me with it. Here is my honest answer, and it might surprise you coming from a guy who owns one.

An IUL is not really an investment. It is permanent life insurance that also builds cash value, and that cash value can grow with a market index, with a floor under it and a cap over it. Whether an IUL is worth it for you depends on the job you are hiring it to do. Let me give you just a couple things about how I think it through.

Is an IUL a good investment?

An IUL can be a good piece of a financial plan, but it is a poor fit if you judge it only as an investment. If all you want is the most long term growth for the lowest cost, a low cost index fund inside a 401(k) or Roth IRA usually wins, and I will say that out loud.

Where an IUL earns its keep is everything an investment account cannot do on its own. It pays a death benefit to your family from day one. It puts a floor under your index credits. Many policies include living benefits. And it gives you a way to reach cash value that can come out without income tax when the policy is set up and kept the right way.

Here is my real opinion. I don't call IUL an investment at all. I call it protection with a growth engine. If someone pitches you an IUL as an investment first and life insurance second, slow down. That is usually where the disappointment starts.

What do you actually get when you buy an IUL?

You get a life insurance contract with three working parts: a death benefit, a cash value account, and the rules for crediting index interest. Federal tax law spells out what counts as life insurance in 26 U.S.C. 7702, and meeting that definition is what gives a policy its tax treatment. The NAIC, the national group of state insurance regulators, describes indexed universal life as coverage where the interest is tied to outside indexes and a minimum interest rate is guaranteed. You can read that on the NAIC life insurance page.

In plain words, here is what is inside:

• A death benefit that is generally paid to your beneficiaries free of federal income tax under 26 U.S.C. 101.
• Cash value that earns interest based on an index, limited by a cap, a participation rate and a floor.
• Flexible premiums, within limits, so you can put in more in good years.
• Living benefit riders on many policies, which can let you use part of the death benefit early for a qualifying chronic, critical or terminal illness. Riders vary, and some carry charges.
• Access to cash value through withdrawals and policy loans. That access is generally income tax free only when the policy is properly structured, is not a modified endowment contract (MEC), and stays in force.

If you want the full mechanics first, start with how indexed universal life policies work.

What does an IUL cost, and why does it matter so much?

An IUL costs more than an investment account because you are paying for life insurance every month, and those charges are heaviest in the early years. That is the honest tradeoff, and anyone who skips over it is not being straight with you.

• Cost of insurance, the price of the death benefit, which rises as you get older.
• Premium loads, a percentage taken off each payment before it reaches your cash value.
• Monthly policy and administrative charges.
• Charges for any riders you add.
• Surrender charges if you cancel in the early years. Depending on the contract, they can last a long time.

FINRA puts it simply on its investor page on insurance: with universal life, the cost of your insurance and sometimes other costs come out of your cash value. I break down each charge in the IUL fees to look for. When you look at any policy, ask for the total charges over the first 10 years in dollars, not percentages. That one number tells you a lot.

Is an IUL worth it compared with just investing the money?

An IUL is worth it compared with investing only if you value the protection and the floor enough to give up some upside and pay the insurance costs. If you truly do not need a death benefit, you are paying for something you will not use.

Think of it like this. An index fund rides the whole market, the great years and the ugly ones, at a very low cost. An IUL takes a slice of the good years, skips the losses on its index credits in the bad years, and charges you for the insurance along the way. In a long, strong run the fund usually comes out ahead. In a choppy stretch, or if you pass away early, the IUL can look a lot better, because the death benefit shows up either way.

So the practical question is not which one grows faster. It is this. What happens to your family if you don't make it to retirement? And what happens to your income if the market drops the year you retire? If those two questions keep you up at night, an IUL starts to make sense as a piece. If they don't, keep it simple.

When is an IUL worth it?

An IUL tends to be worth it when you need lifelong protection, you can fund it steadily for 10 years or more, and the basics of your plan are already handled. Here is who I see it fit best:

• People who want permanent coverage, not just coverage for 20 or 30 years.
• People already getting their full 401(k) match with an emergency fund in place. More on that in IUL vs 401(k).
• High earners who cannot contribute to a Roth directly, or who already fund one. See IUL vs Roth IRA.
• People who want another tax advantaged bucket for retirement income next to their other accounts, which I cover in using an IUL for retirement.
• Families who care about legacy and like having living benefits if their health changes.
• Business owners who need coverage that can also build value over time.

Who is an IUL NOT a good fit for?

An IUL is not a good fit for anyone who needs that money somewhere else first, or who cannot keep the policy funded. I would tell you to wait, or skip it, if:

• You carry credit card debt or have no emergency fund yet.
• You are not getting your full employer match.
• You may need this cash in the next few years. Surrender charges make early exits expensive.
• You only need coverage while the kids are young or until the mortgage is paid. Term is usually far cheaper for that.
• You want the full upside of the market and you are fine riding out the drops.
• Your age or health would make the insurance costs too heavy. Here is what IUL underwriting looks at.

Just to be completely clear: if that is you, an IUL is not a good investment for you right now. Maybe later, maybe never, and that is fine.

How can you tell if a specific IUL is a good one?

A good IUL is designed for your goal, funded properly, and illustrated with realistic assumptions. The product matters, but the design matters more. Here is what I look at:

• If building cash value is the goal, it is funded close to what the tax rules allow without crossing into a MEC under 26 U.S.C. 7702A. Crossing that line changes how loans and withdrawals are taxed.
• The illustration shows the guaranteed column right next to the projected one. The NAIC explains on its life insurance illustrations page that illustrations show both guaranteed and non guaranteed values, and that special rules limit how rosy an indexed policy can look on paper.
• The illustrated rate is modest, and you have also seen what happens at a lower rate.
• You understand the crediting choices. Here are the indexed credit strategies I walk people through.
• You see the plan for loans before you sign, not after. Start with these IUL loan strategies.

That is what I mean by a well structured IUL. Illustrations are hypothetical and not guaranteed, and results depend on the policy and the insurance company.

Where does an IUL fit in a full financial plan?

An IUL fits after the basics, as one piece next to them, never instead of them. When I sit down with someone, this is the order I look at:

1. Get your full employer 401(k) match. Nothing beats free money.
2. Pay off high interest debt.
3. Build your emergency fund, usually three to six months of expenses.
4. Get the right amount of protection. Sometimes that is term, and I will tell you so.
5. Fund your Roth IRA if you qualify.
6. With what is left, decide whether an IUL belongs in the plan for permanent protection, a floor on credits, living benefits and legacy.

God's job is the plans and the provision. Our job is the daily discipline. An IUL can be a great tool for that discipline, but only once the foundation is poured.

Still sorting out whether an IUL is worth it for you? Take the free IUL quiz or ask me a question and I will answer it straight. Already own a policy and not sure it is on track? Run the free IUL policy check up. Does that make sense? I'm here for you.