Indexed Universal Life (IUL) Insurance Explained – Forbes Advisor

If you’re looking for life insurance with the opportunity to grow cash value at more than a low fixed rate, you might be looking at indexed universal (IUL) life insurance.

Some life insurance agents have pushed hard on pitching IUL policies in recent years. And these policies can have risks that many buyers aren’t aware of. Before you pull the trigger on buying an IUL policy, make sure you fully understand the potential downsides.

What Is Indexed Universal Life Insurance?

Indexed universal life is a sub-category of universal life insurance. Universal life insurance policies are distinguished by a feature that lets you skip or underpay the premiums within certain limits. Similarly, it’s possible to adjust the death benefit within certain parameters. Like other permanent life insurance policies, IUL policies can last the duration of your life, as long as the required premiums are paid.

How Does Indexed Universal Life Insurance Work?

The different types of universal life insurance can be sorted out by how cash value works. With IUL, the cash value is tied to one or more indexes, such as the S&P 500, Russell 2000, EURO STOXX 50 or others.

You also have the option to put part of your cash value toward a fixed account to cushion against the risk of index downsides. For example, if you’re getting close to retirement, you may decide to move more cash value funds into the fixed account.

You can choose which indexes you want to use based on the choices offered, which can diversify your investment outcomes if one index goes down. You can generally change your allocation among indexes at any time.

If the policy is in force when the insured person dies, the beneficiaries listed in the policy will be paid the death benefit tax-free.

Building Cash Value

With every premium payment you make, a portion goes into the cash value account. The other part of your premium payments goes to administrative costs and the cost of insuring you. Based on the index’s rate of return, the life insurance company calculates how much to credit to your cash value.

If the index drops, your policy terms will dictate how much you can lose, based on the “floor” stated in the policy. The floor is the lowest rate that will be applied to your cash value. If it’s 0% (or higher) you’ll be protected from losses in the index. The floor does not change while you have the policy.

No matter how well the index does, caps and participation rates limit cash value gains.

• Cap: The cap limits your cash value gain above a certain percent—even if the index performs above that percentage. For example, if your cap is 8% and the index rises by 12%, you’re still credited only 8%. Be aware that the cap can change during the time you have an IUL policy.
• Participation rate: The participation rate can further limit the potential gains your cash value can make. The participation rate defines what percentage of the index’s gains will be credited to your cash value. This is generally anywhere from 25% to above 100%. For example, if your IUL has a participation rate of 100%, your cash value will be credited with all of the gains of the index, up to your cap. The insurer could choose to change the participation rate during the time you own the policy.

If you’re considering buying an IUL policy, check the policy illustration for the cash value projections and other numbers, but don’t be sold based on the non-guaranteed projections. Make sure you know what the guaranteed projections are, so that you’re not shocked if the policy performs worse than the rosy, non-guaranteed columns of numbers.

Crediting Rate

Understand how any gains in your indexes will be credited to your cash value. Common methods include the following.

Accessing the Cash Value

As with other cash value policies, there are ways to take out money from your cash value:

• Policy loan: You can take a loan against the cash value and pay it back whenever you like. IUL loans could be “fixed interest loans” or “index loans.” The insurer will charge loan interest, such as 3.5% to 6%, that also needs to be paid back. If you don’t pay the full loan amount back, the balance will be deducted from the death benefit paid to beneficiaries.
• Policy withdrawal: You can take a straight withdrawal of cash value without any intention of paying it back. The insurer will deduct the withdrawal amount from the death benefit paid to beneficiaries.
• Policy surrender: If you want to terminate the policy, you can inform the insurer and receive the cash value minus any surrender charges.

Adding Riders

Like other life insurance policies, you’ll generally have the option to add a variety of life insurance riders when you buy an IUL policy. Riders add coverage features that can address specific concerns you want to cover. For example, here are some of the rider options for the BrightLife Grow IUL policy from Equitable:

• 2% interest guarantee endorsement: Provides a minimum accumulation value under certain circumstances.
• Cash value plus rider: Reduces the surrender charge if you give up the policy within the first eight years.
• Charitable legacy rider: Provides an additional 1% of the death benefit to the charitable organization of your choice, at no extra cost.
• Children’s term insurance rider: Adds term life insurance for children.
• Disability waiver of monthly deductions: Waives all policy charges if the insured person has been totally disabled for six months.
• Living benefits rider: Allows the policyholder to receive a portion of the policy’s death benefit if the insured person has been diagnosed with a terminal illness and no more than 12 months to live.
• Loan extension endorsement: Ensures that the policy will not lapse due to a certain level of loan balance.
• Long-term care services rider: Pays a monthly benefit if the insured person is chronically ill and needs a home health care provider or long-term care facility.
• No lapse guarantee rider: Ensures the policy will not lapse as long as the required premiums are paid and policy loans don’t exceed a certain level.
• Option to purchase additional insurance: Lets the policyowner increase the base face amount or buy a new policy, without evidence of insurability.
• Return of premium at death benefit rider: Pays an additional death benefit related to the amount of premiums that were paid in.

Cost of Indexed Universal Life Insurance

Quotes for indexed universal life insurance can vary widely depending on the policy, the insurance company and the age and health details of the buyer.

But don’t focus solely on quotes if you’re buying IUL.

Make sure to examine the projections of the policy’s potential for cash value accumulation. Because no one can predict how well an index will perform, keep in mind that the projections are estimates and not guarantees. In addition, the projections may not reflect certain fees and caps.

Don’t buy an IUL policy without understanding all the fees involved and which parts of the projections are guaranteed.

Who Sells IUL Policies?

Based on policy performance data supplied by Veralytic, these are the best indexed universal life insurance companies for 2025:

Pros and Cons of Indexed Universal Life Insurance

Because IUL policies are complicated products, and there have been allegations of deceptive marketing by some agents, there is a risk of buying an IUL product that you’ll regret.

“They are complex products sold with false promises and deceptive marketing,” said Birny Birnbaum, executive director of the nonprofit Center for Economic Justice, when warning consumers about the problems with indexed universal life insurance. “Stay away from them.”

It’s important to weigh the possible benefits of IUL against the costs and complexity.

When Is Indexed Universal Life Insurance Taxable?

Life insurance death benefits are always paid tax-free, but there could be taxes if you access the policy’s cash value while you’re alive. These tax-triggering situations apply to all cash value policies:

• If you take a policy loan and the loan interest deletes the cash value and the policy lapses, the loan amount can be taxable.
• If you take a withdrawal from cash value, the amount “above basis” is taxable. This is essentially the portion of the withdrawal made up of investment gains.

What Happens If an IUL Policy Matures?

Indexed universal life insurance policies typically “mature” when the insured person reaches a certain age, as outlined in the policy, such as 100 or 121.

With some IUL policies, the benefit paid if the policy matures is only the cash surrender value, no matter how small that surrender value is, says Barry D. Flagg, a Forbes Advisor board member and founder of Veralytic, an analytics company that tracks the performance of life insurance policies.

With other IUL policies, the benefit paid if the policy reaches maturity is the full death benefit. Unfortunately, this payment would be fully taxable because the IRS doesn’t categorize it under Section 101 of the Internal Revenue Code as a death benefit.

Some IUL policies will extend the maturity timeline if the insured person is still living on the maturity date. In these cases, the policy pays the death benefit tax-free to beneficiaries when the insured person dies.

Is IUL Right For You?

Indexed universal life insurance policies are complex and can carry high cost, but “are worthy of consideration for life insurance buyers who can tolerate some risk of loss in exchange for some opportunity to gain better than fixed‑income performance,” says Flagg.

Other types of life insurance may meet your needs better.

Comparing Indexed Universal Life to Other Policy Types

Tips for Indexed Universal Life Insurance Buyers

It’s best to work with an experienced financial advisor to determine if IUL is truly the right product for you. If it seems to be, still consider these issues.

Quotes Can Be Misleading About the True Cost of a Policy

“Current rules in most states and for most life insurance types permit brokers, agents and insurers to quote low premiums and project high growth, giving the appearance of low costs, while actually charging high costs without disclosing these high costs,” says Flagg of Veralytic.

In addition, agents and insurers don’t have to disclose the higher risks of future “premium calls” for more than the amounts originally quoted as premiums to cover these high costs.

“IUL proposals are particularly susceptible to such bait‑and‑switch practices, so buyers of life insurance considering IUL must insist on full disclosure of year‑by‑year costs and performance requirements,” says Flagg. Life insurance buyers can also connect with a financial advisor who will work with Veralytic for independent verification that costs are competitive and the policy’s performance requirements are reasonable relative to your risk tolerance.

Risk of Performance Enhancers

Some IUL products charge more (in some cases a lot more) to purchase additional options for “performance enhancers” on some equity indexes, says Flagg. When these additional options mature “in‑the‑money,” you receive the value of the enhanced performance. But if these additional options expire “out‑of‑the‑money,” you’ll lose the entire cost of those additional options, says Flagg.

So while IUL products are often marketed to offer equity market participation with no downside, be aware of the risk of loss in IUL products with “performance enhancers.”

Projections Are Not Based on Actual Historical Performance

IUL proposals do not reflect actual historical performance, warns Flagg.

“While historical performance is no guarantee of future results, historical performance is generally accepted as a gauge for performance that’s reasonable to expect. However, performance projections in IUL proposals reflect ‘back‑tested’ hypothetical performance, not actual historical performance,” he says.

“These ‘back‑tested’ hypothetical performance projections are calculated using participation rates, caps and spreads that insurers can and do change at their sole discretion at any time of their choosing. As such, ‘back‑tested’ hypothetical performance is unreliable as a gauge for performance that’s reasonable to expect because insurers can and do regularly change their performance factors. For these reasons, these ‘back‑tested’ hypothetical performance projections are now subject to lawsuits for being misleading,” explains Flagg.