Indexed universal life insurance: What it is & how it works

Indexed universal life insurance offers permanent coverage and a cash value growth tied to the performance of market indexes. It’s more flexible than other permanent policies, but also more expensive and complex.

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Tory CrowleyAssociate Editor & Licensed Life Insurance AgentTory Crowley is an associate editor and a former licensed insurance agent at Policygenius. Previously, she worked directly with clients at Policygenius, advising nearly 3,000 of them on life insurance options. She has also worked at the Daily News and various nonprofit organizations.&Katherine MurbachEditor & Licensed Life Insurance AgentKatherine Murbach is an editor and a former licensed life insurance agent at Policygenius. Previously, she wrote about life and disability insurance for 1752 Financial, and advised over 1,500 clients on their life insurance policies as a sales associate.

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Antonio Ruiz-CamachoAntonio Ruiz-CamachoAssociate Content DirectorAntonio helps lead our life insurance and disability insurance editorial team at Policygenius. Previously, he was a senior director of content at Bankrate and CreditCards.com, as well as a principal writer covering personal finance at CNET.
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Maria FilindrasMaria FilindrasFinancial AdvisorMaria Filindras is a financial advisor, a licensed Life & Health insurance agent in California, and a member of the Financial Review Council at Policygenius.

Updated|4 min read

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Indexed universal life insurance (IUL) is a type of permanent life insurance policy that doesn’t expire and comes with a cash value that earns interest based on a stock market index, such as the S&P 500. It offers the flexibility of universal life insurance, which allows you to use the cash value to cover your premiums and even adjust your death benefit.

IUL policies can offer greater growth potential than other cash value policies, but they’re also more expensive and complex. If you’re a high-net-worth individual looking to diversify your investment or estate planning portfolio with a life insurance policy tied to the stock market, IUL might work for you. But if you’re just looking for a permanent life insurance policy with a guaranteed death benefit and cash value, whole life might be a better fit for you.

Key takeaways

  • Indexed universal life insurance (IUL) has a cash value component that grows based on a market index.

  • IUL policies allow you to adjust the death benefit and pay your premiums with your cash value as time goes on.

  • IUL is more expensive, complex to manage, and its growth potential less predictable than standard whole life insurance.

How does indexed universal life insurance work?

Indexed universal life insurance works similarly to other types of permanent life insurance — your policy stays in effect for your whole life as long as you keep paying the premiums.

Part of the premiums you pay are used to cover the cost of the policy and the rest goes toward the cash value account. Similar to a universal life policy, you can adjust the death benefit within set limits and use gains from the cash value to pay your premiums.

What makes indexed universal life insurance unique is the way the cash value works.

  • Cash value growth is based on a market index chosen by the policyholder.

  • While the insurer that issues the policy chooses which index funds are available to invest the cash value on, ultimately the policyholder chooses how the money is allocated with the help of their advisor.

  • IUL policies have a floor of 0% (so you won’t lose money), but the interest rates aren’t fixed. Most insurers will specify a maximum interest rate (called a cap rate) so growth is limited. 

The cash value of IUL policies has potential to grow more rapidly than other types of permanent life insurance, but also has lower growth potential compared to just investing in the market directly. 

Pros of indexed universal life insurance

Indexed universal policies can help with estate planning and provide an additional investment vehicle if you’ve already maximized contributions to traditional investment accounts, like a 401(k) plan or IRA. 

  • You can see larger cash value growth with IUL than with other permanent policies, depending on your index investment performance and cap rate. 

  • IUL can help pay off large estate costs or pass a tax-free inheritance if other assets are large enough to trigger estate taxes.

  • You also have the advantage of a flexible death benefit and premium payment plan if needed, meaning you can increase or decrease the size of the death benefit (within limits) as your coverage needs change, and use the cash value you’ve gained to pay your premiums. However, you may have to take a medical exam if you want to increase coverage — it depends on the parameters of your policy.

Cons of indexed universal life insurance

IUL policies are generally more expensive and more complex than term life insurance policies and other permanent policies, like whole life. But the primary downside of indexed universal life insurance is the complications and nuances associated with the market index used as a reference and the growth of the cash value.

  • The policyholder takes on much more investment risk than they would with other life insurance products. If the stock index doesn’t perform well, you’ll have to pay more into your policy to prevent it from lapsing, and it can become difficult to afford.

  • The earnings may be capped. If the S&P 500 earns 8% but your policy is capped at 4%, you won’t see the full growth reflected in your cash value. 

  • IUL policies don’t take into account dividend yields, which creates another situation in which the growth rate credited wouldn’t match the index growth — dividends are usually paid out quarterly or annually to the policyholder if the insurance company overperforms financially. 

  • Your growing cash value may come with fees that are built into the cap rate. If you want to use your cash value, you’ll encounter restrictions and taxes if you withdraw more money than you’ve paid into the policy.

With IUL, you need to spend a lot of time studying your index options or be very comfortable with the guidance of the company from which you're buying to make an informed insurance choice.

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Alternatives to indexed universal life insurance 

While IUL policies can be a good option for savvy investors with estate planning and retirement needs, other options might be a better fit for you depending on your needs. 

→ Learn more about different types of life insurance

Whole life insurance

Whole life insurance also offers permanent coverage, a death benefit, and cash value. However, unlike IUL policies, the death benefit in whole life policies is guaranteed and the premiums remain the same throughout the duration of the policy.

But the main difference between both whole life and IUL is in how the cash value grows. The cash value in a whole life insurance policy grows at a fixed rate set by your insurer, which makes this type of policy more predictable and easier to manage than IUL.

Indexed universal life

Whole life

Policy duration

Permanent

Permanent

Death benefit

Flexible

Fixed

Cash value accumulation

Based on a market index

Set by your insurer at a fixed rate

Premiums

Flexible

Level

Term life insurance

Term life insurance is the most affordable and easier to manage life insurance option on the market. Term life lasts for a set period of time, usually between 10 and 30 years, and then it expires. Unlike IUL, it doesn’t have a cash value component — term life policies offer basic protection in the form of a guaranteed death benefit.

If you’re simply looking for a policy that provides a financial safety net for your family in the event of your death, term life can be a great fit for you. You can complement your retirement and investment with other products like index funds, high-yield savings accounts, 401(k) plans, and IRAs. 

Indexed universal life

Term life

Policy Duration

Permanent

10 to 40 years

Death benefit

Flexible

Fixed

Cash value accumulation

Based on a market index

N/A

Premiums

Flexible

Level, more affordable

→ Explore the differences between whole vs. universal vs. guaranteed universal life insurance

Is indexed universal life insurance worth it?

IUL can be a good option for high-net-worth individuals with complex financial and estate planning needs with higher risk tolerance. For everybody else, it isn’t worth the cost. 

But whether IUL is worth it for you ultimately depends on your financial situation. Most people don’t need their life insurance policy to last their entire lives. Once you pay off debts, have few dependents, and become self-insured, it’s usually not worth continuing to pay for a policy.

If your primary goal is to replace your income and provide a financial safety net for your family, it’s hard to justify the extra costs associated with an indexed universal life insurance policy. A term life insurance policy paired with an outside investment plan is more affordable and can provide a better ROI.

Indexed universal life insurance is also complex and can be difficult to manage. It’s common for IUL policies to lapse if they’re underfunded or if the market index underperforms — so it can be hard to know exactly how well the policy will work out for you long-term.

If you’re considering purchasing indexed universal life insurance, it’s important to speak with a trusted financial professional first to make sure it’s right for you.

Other types of permanent life insurance

Frequently asked questions

How does an indexed universal life policy work?

The policy premiums you pay go toward both a death benefit and a cash value component. The death benefit doesn’t change, but the cash value account grows based on the performance of a specific stock index.

Is indexed universal life a good investment?

IUL is not the best investment for most people. Even though there’s potential for large investment gains, performance can be unpredictable compared to traditional investing because cash value growth is tied to market performance. IUL also costs significantly more than other permanent policies or even term life insurance. While IUL policies have a floor of 0%, your rate may also be capped so that your growth is less than you’d get from investing separately.

Most of the time, you’ll be better off getting a term life insurance policy and investing the premiums you saved in in the stock market, where there is no cap on its growth.

Can I access the cash value account of my indexed universal life policy?

After the surrender period (usually the first seven to 14 years of your policy), you can withdraw from the cash value of your IUL policy up to the amount you’ve paid into it without incurring fees or taxes. You can also cash out your policy entirely by surrendering it and forfeiting your coverage (though this may come with high fees).

Authors

Tory Crowley is an associate editor and a former licensed insurance agent at Policygenius. Previously, she worked directly with clients at Policygenius, advising nearly 3,000 of them on life insurance options. She has also worked at the Daily News and various nonprofit organizations.

Katherine Murbach is an editor and a former licensed life insurance agent at Policygenius. Previously, she wrote about life and disability insurance for 1752 Financial, and advised over 1,500 clients on their life insurance policies as a sales associate.

Editor

Antonio helps lead our life insurance and disability insurance editorial team at Policygenius. Previously, he was a senior director of content at Bankrate and CreditCards.com, as well as a principal writer covering personal finance at CNET.

Expert reviewer

Maria Filindras is a financial advisor, a licensed Life & Health insurance agent in California, and a member of the Financial Review Council at Policygenius.

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