Max-Funded IUL: A Deep Dive

Is all the social media hype about “max-funded IUL” really warranted, or is it just a scam, like many traditional financial pundits claim?

A maximum funded IUL may be ideal for those who are risk-averse, susceptible to future higher tax increases, and/or maintain excess liquidity for their own business or outside investment deals. However, it’s crucial to thoroughly understand Indexed Universal Life’s intricacies and consider your financial goals before proceeding.

This article will boil down the essence of this type of hybrid life insurance coverage with a market-linked savings component so you can see if its benefits outweigh the downside. Like anything else, the answer will obviously depend on your situation.

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What is Max-Funded Indexed Universal Life Insurance & Why Consider it?

Max-funded IUL is simply an Indexed Universal Life insurance policy optimized for cash value growth by stuffing a smaller amount of life insurance protection with the maximum allowable premium payments. This reduces IUL’s overall cost structure and stays within IRS guidelines to preserve its income tax-free treatment.

It’s counterintuitive, I know.

Since we’re dealing with insurance, you’re probably thinking, “What’s the most amount of coverage you can get for the least amount of money?”

With a max-funded IUL, it’s the opposite. “What’s the least amount of life insurance coverage you can legally shrink-wrap around my cash value account?”

Like any other type of permanent life insurance policy, max-funded IUL offers a cash value component technically designed to support the cost of its future death benefit. Although life insurance protection is rarely the top priority, the Roth-like favorable tax treatment of the cash value only exists because the death benefit ultimately pays out to your beneficiaries tax-free.

With $36 trillion of national debt looming over us, the ability to take income-tax-free distributions at any age will be crucial (not just after age 59.5).

What sets max-funded IUL policies apart from other life insurance policies is how these insurance companies grow the cash value by tracking a stock market index within specific parameters. Generally, IUL policies track the upside of the S&P 500 index up to a certain cap in positive years, while protecting you from market losses with a guaranteed 0% floor in negative years.

How a Max-Funded IUL Works

When you make premium payments into any permanent life insurance policy, a portion goes toward acquiring the permanent death benefit (which preserves your tax benefits), and excess premiums paid are allocated to the cash value component (which can grow with the indexed crediting strategies).

By max-funding an Indexed Universal Life policy, you are disproportionately shifting the allocation of premiums towards the cash value, thereby reducing the initial and ongoing costs associated with the death benefit.

Where max-funding an Indexed Universal Life policy makes a huge difference is by reducing the ongoing fee drag. Contrary to popular belief, the bulk of IUL’s fees, charges, and commissions are based largely on how much death benefit you’re buying for those excessive premium payments.

How Max-Funded IUL Reduces Fee Drag

The ongoing cost of insurance is based quite literally on what life insurance companies call “the net amount at risk,” which is the amount of death benefit they would have to pay out over and above the cash value you already have access to. Every month, the insurance company takes a snapshot of your max-funded IUL and assesses fees only for the death benefit that is over and above your cash value.

So, for most people, an optimally designed IUL starts with an increasing death benefit during the years you plan on paying premiums. This means your life insurance coverage starts small and expands as your cash value grows. Once you are finished paying premiums and the cash value has enough critical mass to cover the costs, we level out the death benefit or perhaps even reduce it manually to bring down the annual fees.

We’ve found the all-in average costs over the life of a max-funded IUL to be around 1%-2% annually as a percentage of your cash value. This is similar to professionally managed money.

After the first 10 years after all premiums have been paid, the ongoing annual fees and cost of insurance for a max-funded IUL policy during retirement will be 0.5% or less, which is actually closer to the cost of cheap index funds

Nonetheless, your cash value is still being institutionally managed. In fact, you will have erased the threat of market risk, not to mention the added death benefit protection and tax advantages inherent with Indexed Universal Life insurance.

How a Max-Funded IUL Grows

Your cash value, made up of surplus premium payments and prior indexed crediting, grows based on the performance of an underlying stock market index. Typically, max-funded IULs will track the S&P 500 with either a cap on the maximum return (these days in the 9%-11% range) or a limited participation rate (meaning you only participate in 55-75% of the S&P 500’s growth but without any cap).

What IUL policyholders gain by limiting the growth of an external index strategy with IUL’s caps or participation rates is a contractual floor limiting losses to 0% or low single digits, regardless of how much the S&P 500 loses. That said, despite having even a guaranteed 0% floor, the ongoing insurance cost will cause your cash value to erode slightly in down market years.

To clarify, I am NOT suggesting that any of these IUL policies will outperform the S&P 500 over 40–50 years. However, a max-funded IUL policy may be ideal for funds you want to keep safe and liquid while still growing at a reasonable rate to outpace inflation.

When looking at the last 86-year history of S&P 500 returns, we can see that more than 3/4 of the time the S&P was up and less than 1/4 of the time it was down. However, when the S&P was down, it was down by double digits the majority of the time.

“Stocks tend to take the stairs on the way up, but they use a window on their way down.”

Anyone who’s invested for a while can relate to this funny statement, and the graphic below from a well-known mutual fund statement proves the point.

Although the caps on IUL can restrict growth during the best years, certain products also have crediting strategies where you opt into an additional annual fee of 2-3% for better growth potential.

Currently, these added fees can buy up a cap to around 15% or a participation rate tracking 85%-90% of the S&P 500’s upside, with your all-in downside limited to the low single-digit range from the added fees. Note: You can choose to opt in and out of these additional fee strategies annually whenever you want to increase or reduce your exposure.

The Annual Reset Feature Within all IUL Policies

All of IUL’s annual indexed crediting strategies have a feature called the “annual reset”. The 0% floor of IUL locks in prior gains and protects them from market losses, but this annual reset feature allows you to track the following year’s growth from the new lower starting point of the S&P 500 after market downturns.

A 401(k) or index funds in a brokerage account would need massive gains just to get even from the market losses before the account balance can make new highs. As you can see below, not nearly as much in gains would be needed for a max-funded IUL to reach new highs, even if you opt for a more aggressive index crediting strategy charging an extra fee.

Benefits of Max-Funded IUL

We would never claim that Indexed Universal Life will outperform the S&P 500 over any long-term timeframe, not even a max-funded IUL. However, it does have some unique benefits and planning opportunities that can’t be overlooked, both in retirement and beforehand:

No Losses From Market Downturns

Haters of Indexed Universal Life always compare it to actual S&P 500 index funds, when the two financial products have completely different risk profiles. As we saw during COVID and the Great Recession of 2008, the stock market can shed 30% of its value within 2 months. Heck, we even saw US Treasury Bonds lose over 20% of their value in 2022.

Max-funded IUL policy losses will most often be limited to around 0.5%- 2% simply to pay for the ongoing cost of insurance (and tax forgiveness linked to the death benefit). So, if losses are limited to nominal single digits, then shouldn’t we be comparing a max-funded IUL to other financial products with a similar risk profile, like T-bills, CDs, and high-yield savings accounts?

Competitive Risk-Adjusted Growth

The ability to earn double-digit crediting in bull market years while limiting losses to the cost of insurance in bear market years seems like a worthy proposition, since the S&P 500 has gone up 3/4 of the time over the last 86 years.

Also, certain products have higher caps and even uncapped S&P 500 strategies for an additional fee of around 1%-3%. That way, you can be mentally prepared to stay in the market and capture strong double-digit returns during volatile up markets, knowing you have a conservative floor if the bottom falls out from under the external index.

Could the raw S&P 500 earn more long-term? Almost certainly!

However, can you take advantage of some of the best generational buying opportunities in history for stocks and real estate by borrowing against your max-funded IUL that avoided the market crash? Probably not. It’s unlikely you’d sell stocks or mutual funds when they’re down to buy real estate that is down.

Since death benefits paid income tax-free go towards protecting widows, orphans, and failing businesses, the government will essentially reward you for cash value with Roth-like tax advantages. Book your free consultation with a max-funded IUL expert to discover the optimal product and growth strategies for your specific situation.

Tax-Deferred Growth & Tax-Exempt Withdrawals

Any tax benefits created by legislatures to drive behavior deemed to provide a societal good, and life insurance income tax efficiency is no different. Since death benefits go towards protecting widows, orphans, and failing businesses, the government will essentially reward your cash value with Roth-like tax advantages.

For everybody except those in the absolute lowest tax brackets, the tax-sheltered nature of IUL has a massive advantage over traditional banking products like CDs and high-yield savings accounts. Imagine earning 5% and then forgoing 30% of your growth just to pay state and federal taxes; your real yield equals 3.5%.

Conversely, if your max-funded IUL earned 6% income tax-free, you must earn over 8.5% in taxable savings products to achieve the same net yield. If you’re paying over 40% in state and federal taxes, you’d need to earn over 10% to have it equal a net 6%

With $36 Trillion of national debt and growing, having a pool of liquid assets immune from taxation will be key. This is especially true for retirees, where most of their retirement savings are allocated to 401(k)s that have never been taxed. Being able to strategically pull from a max-funded IUL without bumping into the next highest tax bracket can help them make their retirement savings last longer since fewer shares need to be sold to produce the same net after-tax income.

Chronic Illness Riders

Most Indexed Universal Life policies come equipped with some sort of Chronic Illness Rider for no additional cost. Chronic illness riders allow policyholders to access a portion of their death benefit income tax-free even while still alive, assuming they are diagnosed with a qualifying chronic illness or critical injury.

The ability to tap into the death benefit, even though you aren’t dead yet, can offer peace of mind, knowing that there is a safety net available in case of unexpected health issues or debilitating injuries. This feature can provide crucial financial relief, helping to cover medical expenses or everyday living costs during difficult periods without requiring the depletion of other savings or assets.

The Ultimate "Retirement Buffer"

Even though we are discussing Max-Funded IUL for its indexed growth features, it is, after all, an insurance product, and its 3-pronged protection component for retirees is indispensable:

- - Protection from market losses
  - Protection from future higher taxes
  - Protection against premature death or serious illness/injury

If you are committed to using a max-funded IUL policy to protect yourself from having to over-withdraw from your retirement accounts, then most of the top performing IUL companies offer some sort of free chronic illness rider just in case.

Many advanced retirement planners advocate having a “buffer asset” in place to draw income during market crashes or periods when taxes on 401(k) withdrawals would be too steep. This keeps you from having to sell more shares of your taxable stocks or mutual funds inside a 401k simply to produce the same amount of net retirement income you’ve grown accustomed to.

Since a max-funded IUL in retirement would be immune to both market downturns and taxation, it is really the ultimate buffer asset. This allows you to pause retirement income from traditional sources when it is less efficient. Take a look at this matrix from Hutch’s IUL for retirement article, which shows when and how to use max-funded IUL as a buffer asset.

Most Indexed Universal Life insurance agents model IUL for as a steady “retirement income supplement,” but we believe during the biggest market crashes or worst eras of tax policy, you may need more of a “retirement income replacement” for a period of multiple years.

Thankfully, you can borrow against a max-funded IUL’s cash value without depleting its usefulness and keeping its trajectory on the compound interest curve. You don’t have to pay it back, but you may want to so you can use it again and again for any of the 3 circumstances above.

Ability to Borrow Against Your Continuously-Allocated Cash Value

With a max-funded IUL, you can take a loan at any time for any reason while keeping your full cash value balance allocated to indexed crediting strategies. Whether you’re taking advantage of an outside investment opportunity, or handling a family or business emergency, or taking supplemental retirement income, your entire cash value balance stays allocated within your max-funded IUL policy.

In fact, there is an entire movement around using life insurance as your own private bank called “infinite banking.” The idea is to keep your tax-exempt cash value continuously compounding inside the policy, even if you borrow against it for liquidity to use for other things. That way, you pay simple interest on a flat or decreasing policy loan balance, while earning compound interest on an increasing balance.

Unlike traditional loans with strict terms and due dates, any life insurance loan is against the death benefit. So, technically, no payments are ever due, and your death benefit can pay off any outstanding loan balance.

Also, most of the best performing IUL policies have something called an “overloan protection rider.” This rider keeps your policy from lapsing and you from losing the tax benefits of a permanent life insurance coverage if you take too much income while still alive. Essentially, the rider automatically freezes the last 1% of cash value to ensure that a nominal burial policy gets paid, which negates all tax on prior income tax-free distributions from your IUL.

Problems with Max-Funded IUL

While Indexed Universal Life policies offer numerous benefits, they are not without certain drawbacks. Remember that many of IUL’s risks described below can be mitigated by committing to a max-funded structure. This is because excessive premium payments naturally enhance performance, decrease fees, and increase early surrender value so you can exit the product if absolutely necessary.

Inherent Complexity

One common concern is the complexity behind these products, which can be difficult to understand and manage. Indexed Universal Life has multiple moving parts, but thankfully, its statements exhibit full transparency, showing you to the penny what is being charged and what is being earned each month within max-funded IUL.

Again, serious scrutiny will only be needed to keep an IUL in force when it is not max-funded or substantially underperforming market averages. If dealing with complexity is of great concern or there’s a strong possibility you won’t be able to fully fund it within the first 10 years, then perhaps Whole Life insurance vs. IUL may be a better choice.

Indexed Crediting Won't Capture Full Market Upside

It’s true that the various indexed crediting strategies will not outperform or even match the performance of the S&P 500 in raging bull markets. Obviously, IUL caps will stunt cash value growth, and participation rates will water down the performance of any external index strategy. Even IUL’s with uncapped S&P 500 indexed crediting strategies don’t pay dividends, as many critics point out.

None of IUL limiters (like caps, particpation rates, or lack of dividends) are due to malicious intent on the part of the insurance company; they are simply a function of how the option-hedging strategies work under the hood of Indexed Universal Life.

Remember that Indexed Universal Life insurance is meant to complement, not replace, your other wealth-building efforts. In bear markets, a max-funded IUL can provide a safe harbor of liquidity while still staying somewhat exposed to the next bounce. IUL’s risk-adjusted returns in bull markets will certainly outperform short-term bonds and taxable savings accounts, both of which are much closer to IUL’s risk profile than the S&P 500 index.

Fees and Costs May Erode Indexed Crediting

Critics will commonly decry IUL for its fees, charges, and commissions. Again, all of these policy costs can be substantially reduced with a max-funded IUL since you are essentially shrink-wrapping the least amount of death benefit possible around whatever premium payments you’re comfortable making.

Regardless, premium loads, administrative costs, and ongoing costs of insurance are a reality since it is an insurance product. You should have your agent run a detailed report itemizing the different fees and projected performance, not only at favorable market averages but also simulating lackluster returns. That way, you can see the effect on your future cash value and death benefit in these different scenarios to determine if the benefits of your max-funded IUL will be worth the costs.

When a max-funded IUL gets even just average indexed crediting, you’ll find that insurance fees and costs may start out high when you have the least amount of money invested, but then substantially decrease to be on par with cheap index funds around retirement age. This is just the opposite of managed money fees that exponentially grow along with your account balance.

Lack of Guarantees

It’s true that most max-funded IULs naturally lack guarantees for both it’s cost structure and performance options. There are guaranteed maximum charges, but they are usually 3-4 times what is being illustrated. There are minimum possible caps and participation rates, but they are substantially lower than the levels commonly being illustrated.

Quite frankly, the insurance company has a lot of levers to pull to make their product less favorable than what is being shown. This, again, is why max-funding an IUL is so important. Your cash value can outrun the fees in most circumstances, and if not, you can exit the product with most or all of the money you put into it.

This is also why company selection is so important. Some IUL companies have a history of unfavorably changing their cost or performance parameters on their clients after the fact. To be clear, even the top companies needed to lower caps and participation rates when prevailing interest rates dropped, but they have since raised them for all customers. However, there is clearly a trend for certain carriers to more aggressively water down these performance metrics way below market on existing clients to subsidize new unsustainable product offerings they plan to change after the fact.

Is Max-Funded IUL Right for You?

Whether a max-funded IUL policy is right for you will depend mainly on your:

- - ol]:!pt-0 [&>ol]:!pb-0 [&>ul]:!pt-0 [&>ul]:!pb-0″ value=”2″>Sensitivity to Future Tax Increases
  - ol]:!pt-0 [&>ol]:!pb-0 [&>ul]:!pt-0 [&>ul]:!pb-0″ value=”4″>Overall Risk Tolerance

Although max-funding provides sufficient early surrender value to exit if needed, IUL should only be considered as a lifelong investment decision. A max-funded IUL can help tremendously as a retirement buffer and also along the way as your own bank when emergencies and opportunities arise.

We find that most people are overexposed to raw systematic market risk in your 401k, taxable brokerage accounts, not to mention your monthly income from your job or business. Having a pool of liquidity immune to market risk can help you stay afloat in rough times, or possibly help you take advantage of generational buying opportunities using cash value from an unscathed max-funded IUL policy.

Also, with the $36 Trillion of National Debt intensifying the threat of future higher taxes, the tax-exempt nature of Indexed Universal Life can keep you from having to cash out more shares of your taxable investment or retirement accounts than necessary. Yes, you could also draw income from a Roth to keep from bumping into the next tax bracket, but do you really want to cash shares of your Roth when taxes are up, but markets are down?

Almost every retiree will face these 2 issues without a favorable solution. By repositioning inefficient savings accounts or unmatched 401k contributions into a max-funded IUL now can help you become your own banker today and better navigate retirement tomorrow.

Final Thoughts on Max-Funded IUL Policies

Any maximum funded IUL product should be custom-fitted to your unique situation. Be sure to consult with a licensed insurance broker who can shop the best policy offerings and provide personalized insights, so you can determine whether a max-funded IUL is the right fit for your financial future. Also, be sure to look at not only rosey projection or touted market averages, but also how the product performs in extremely unfavorable market environments.

Remember that max-funding the product is meant to maximize the cash value and minimize the pure death benefit, thereby lowering its overall cost structure. However, the permanent death benefit is what keeps you immune from future higher taxes on the money you use while you’re alive.

Max-funded IUL may be ideal for those who are risk-averse, susceptible to future higher tax increases, and/or keep excess liquidity for their own business or outside investment deals. However, it’s crucial to get full transparency so you can thoroughly understand the policy’s intricacies and its impact on your financial goals before proceeding.