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 is not a form of direct investment in the stock market. 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 may 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 with intricate estate planning needs, a higher risk tolerance and a need for permanent life insurance, IUL may be worth considering. But if you want permanent coverage with more predictable cash value and a guaranteed death benefit, whole life or guaranteed universal life may be a better fit.
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 linked to one or more market indexes offered by the insurer.
Policyholders may be able to choose among the insurer’s available index crediting options with the guidance of an advisor, but the cash value is not directly invested in the index or an index fund.
IUL policies typically include a floor of 0%, meaning negative index performance generally will not result in negative credited interest. However, interest rates are not fixed. Most insurers set a maximum credited interest rate, known as a cap rate, which limits growth potential.
Some policies also use a participation rate, which determines how much of the index's gain is used to calculate credited interest. For example, if the index gains 10% and the policy has an 80% participation rate, the credited gain may be based on 8% before applying any cap or other policy rules.
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.
Common Indexed Universal Life Insurance Terms
Index: A market benchmark, such as the S&P 500, used to help calculate credited interest
Floor: The minimum credited rate, often 0%, before fees and policy charges
Cap: The maximum credited rate the policy can receive during a crediting period
Participation rate: The percentage of index gains used to calculate credited interest
Policy charges: Fees and insurance costs that can reduce cash value
Lapse risk: The risk that the policy ends if it is underfunded or cash value is depleted
Pros of indexed universal life insurance
Indexed universal policies can support estate planning goals and may provide tax advantages through tax-deferred cash value growth and access to cash value through policy loans, while also serving as another cash value accumulation option for individuals who have already maximized traditional retirement savings accounts and need permanent life insurance coverage.
You may see larger cash value growth with IUL than with other permanent life insurance policies, depending on index performance, participation rates and cap rates.
IUL can help provide an income-tax-free death benefit to beneficiaries and may support estate liquidity, depending on how the policy is owned and structured.
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 more policy performance risk than they would with more predictable permanent life insurance products. If index crediting is lower than expected, fees and insurance costs may reduce cash value, and the policyholder may need to contribute additional premiums to keep the policy active.
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.
Many index crediting strategies are based on price index performance and do not include dividends from the underlying companies in the index. As a result, credited returns may be lower than the total return an investor could receive from directly investing in an index fund.
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 insurance company from which you're buying to make an informed insurance choice.
Alternatives to indexed universal life insurance
While IUL policies can be a good option for savvy investors with estate planning and retirement income 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.
Learn more about the differences between IUL and whole life insurance
Term life insurance
Term life insurance is one of 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 plan and investments with other products like index funds, high-yield savings accounts, 401(k) plans, and IRAs.
→ 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
Indexed Universal Life Insurance FAQs
Can you lose money in an indexed universal life policy?
Many IUL policies include a 0% floor for index crediting, which means negative index performance generally will not result in negative credited interest. That said, policy charges, fees, outstanding loans and insufficient funding can still reduce cash value over time. In some cases, these factors can cause the policy to lapse if additional premiums are not paid.
What happens if an IUL policy is underfunded?
If an IUL policy does not have enough cash value or premium payments to cover ongoing policy charges and insurance costs, the policy may lapse. Depending on the situation, the policyholder may need to increase flexible premium payments or contribute additional funds to keep coverage active.
Is IUL insurance better than whole life insurance?
Neither type of policy is automatically better. Indexed universal life insurance offers greater flexibility and the potential for index-linked cash value growth, while whole life insurance generally provides more predictable cash value accumulation and a guaranteed death benefit. The right choice depends on your financial goals, risk tolerance and lifelong coverage needs.
Who should consider indexed universal life insurance?
Indexed universal life insurance may be appropriate for high-net-worth individuals who need permanent life insurance coverage, have estate planning objectives, are comfortable with greater policy complexity and have the financial ability to fund and monitor the policy over the long term. Those seeking more predictable guarantees may prefer whole life or guaranteed universal life insurance instead.
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