Why is IUL a Bad Investment: Problems with Indexed Universal Life Insurance
IUL isn’t an investment at all, it’s an insurance product.
I’ve got news for you… Neither investments nor life insurance coverage are as powerful in isolation without some of the other offerings to complement its own shortcomings.
Financial influencers, who make blanket statements declaring Indexed Universal Life Insurance good or bad, fail to educate their audience about either:
- The problems with an Indexed Universal Life insurance policy
- Or the unique planning opportunities IUL can provide.
Since Americans are less prepared for retirement than ever before, this article will shed light on IUL’s good and bad qualities so you can decide if IUL is a bad investment given your situation and financial goals.
At Banking Truths we believe in providing education & modeling so you can decide if this strategy is a good fit for you:
- Get all your questions answered
- See the top policies modeled out
- Never any pressure or hard pitches
Table of Contents
Why IUL is Considered a Bad "Investment"
The main reason why IUL is considered a bad investment is because the S&P 500’s total returns have undeniably outperformed Indexed Universal Life over any multi-decade timeframe.
To make IUL vs. the S&P 500 look superior, life insurance agents have to isolate and cherry-pick the worst decades in stock market history.
Ironically, what makes Indexed Universal Life a “bad investment” is its protective 0% floor. This unique mechanism employed by the insurance company does indeed erase any stock market losses within an IUL, but it also simultaneously limits Indexed Universal Life’s upside potential in bull markets.
- 100% potential loss on investment
- Unlimited annual index gains
- Ongoing stock dividend payouts
- 0% floor limiting losses to annual policy fees
- Capped gains or limited participation rates
- No dividend payments, but potential bonus payments
Interestingly, certain Variable Universal Life products now offer investment options similar to IUL with a -2.5% floor instead of the traditional lossless 0% floor, only with much higher caps and even uncapped S&P 500 options. These VUL products with IUL crediting strategies also have traditional mutual fund investment options for investors who want the option for full stock market participation.
Indexed Universal Life Insurance simply can’t outperform an S&P 500 index fund unless IUL substantially increases its exposure to the underlying stock options. Doing so would erase the IUL policy’s 0% floor and substantially increase the policyholder’s downside risk potential.
However, people rarely put every dollar of their portfolio into their best-performing investments. Otherwise, they wouldn’t even be in an S&P 500 mutual fund. They’d have every dollar in something like Apple or Amazon, right?
The purpose of investing in an S&P 500 mutual fund is to diversify and spread the risk among the top 500 stocks, right?
Keep that in mind when asking these 3 questions:
- Wouldn’t increasing exposure to market downswings defeat the purpose of IUL’s main value proposition: zero market risk? Yes.
- When answering why IUL is a bad investment, are we perhaps answering the wrong question correctly? Yes.
- Should we consider looking at IUL’s true value proposition through a different lens? Yes.
Perhaps then we should explore why so many financial planners are now using Indexed Universal Life as a proxy for bonds as part of a balanced retirement plan.
Is IUL a Good Investment in Retirement?
First of all, Indexed Universal Life isn’t an investment at all, but a life insurance policy with a savings component.
So when asking “Is IUL a Good Investment”, shouldn’t we compare Indexed Universal Life and its 0% floor to investments with a similar risk profile? Rather than compare IUL vs. S&P 500, perhaps we should compare Indexed Universal Life insurance to a combination of bond funds.
Most clients have some amount allocated to bond funds in a balanced 401(k) portfolio or a 2035 target date fund. This is because bonds are considered to be lower risk than something like an S&P 500 index fund.
That said, we can see that in 2022 bonds on average lost about as much as stocks even though the upside potential of bonds is often limited to its yield. Is the risk/reward tradeoff of bonds really worth it?
What about the risk/reward tradeoff of a properly funded Indexed Universal Life policy when drawing income?
One major advantage of using IUL for retirement as opposed to bonds is IUL’s 0% floor. This contractual floor can allow mutual funds that are down to wait for a rebound and fully heal, rather than having to cash out more shares in a down market just to fund your desired income.
Also, since IUL enjoys the tax-advantaged wrapper of permanent life insurance, distributions in retirement can be taken tax-free (so long as you leave at least a minimal death benefit to be paid out). This mean that smaller distributions would be needed from an IUL vs. a 401(k) to satisfy the same amount of desired retirement income.
As a diversifier, IUL is a good investment because of its ability to relieve pressure from traditional retirement assets when they are down in value or subject to high tax brackets in retirement.
Even though pundits say IUL is a bad investment because it doesn’t outperform the S&P 500, its more conservative risk profile and preferential tax treatment makes IUL a good investment to own in retirement (assuming it’s designed, funded, and managed properly) on top of other retirement accounts.
Get all your questions answered and learn about which IUL policies would best fit your situation.
IUL’s Cash Value is a Super-Charged Savings Account
If you listen to enough haters of Indexed Universal Life insurance policies, they’ll tell you that the cash value component of any permanent life insurance product is just a glorified savings component in an insurance wrapper.
We agree!
So if clients already have savings accounts anyway, why don’t we do what big banks themselves do and shrink-wrap insurance around high-performance savings accounts to create super-charge savings accounts that are immune to taxes?
Here’s how IUL cash value improves upon traditional savings accounts:
- Historically better growth rates
- Tax-advantaged growth for life of the policy
- Tax-exempt distributions long before age 59.5
- Built-in protection hedges for death (possibly disability and lawsuits)
Think about it! The best investment buys you’ll ever make will almost always be during a deep recession.
Having money safely growing while staying immune from losses and taxes will help you make the most of well-timed investments whether you’re:
- Investing in Real Estate
- Funding Property Renovations
- Buying Business Inventory or Equipment
- Acquiring Other Businesses (including stocks)
When these deals become available, your existing investments will likely experience a downturn as well. You won’t want to cash out stocks while they’re down to buy stocks or vice versa.
Can IUL work with Infinite Banking?
Yes, Indexed Universal Life can indeed work for the infinite banking concept if the policy is designed, funded, and managed properly because IUL insurance costs increase during the later years.
Infinite banking practitioners generally prefer Whole Life for IBC due to its guaranteed premium, death benefit, and cash value growth. More stability in the underlying insurance product may be more ideal for infinite banking since it entails borrowing for outside investment opportunities, which can fluctuate wildly in value.
Even though Indexed Universal Life provides more stability than stocks, mutual funds, or real estate, it’s still somewhat correlated to the market.
Some of the best times to aggressively borrow against IUL for infinite banking would be when markets are bleeding. Down markets may cause multiple years of 0% crediting inside an IUL, whereas Whole Life would be growing each year no matter what.
Oftentimes, Whole Life’s guaranteed annual interest plus dividends may be enough to service the loan on its own. Indexed loans against IUL investment strategies may produce positive arbitrage in certain years, but nothing in other years.
On average, the IUL crediting strategies should outperform the ongoing loan rate, especially IUL’s with a low locked loan rate. Also, certain VUL policies have IUL investment options that have higher caps and even uncapped options, but also around -3% floor instead of IUL’s traditional 0% floor. Long-term, this may provide greater opportunities for arbitrage, and/or more cash value in the policy when it comes time to borrow.
Another reason why people think IUL insurance is a bad investment, especially for infinite banking, is its cost structure starts out cheap but becomes more expensive as you get older. In addition to managing an equilibrium between your IUL crediting and loan balance, you must also manage the rising cost per $1,000 of insurance.
Thankfully, policyholders are only charged for the difference between their death benefit and cash value. So, the idea is that you will hopefully be paying for less net death benefit over time, which should balance out IUL’s rising cost structure.
If this sounds like too much to deal with, you may want to dig deeper into the key differences between IUL vs. Whole Life insurance for both infinite banking and retirement.
Indexed Universal Life is Insurance, So Is IUL Worth It?
First, let’s address IUL’s insurance component. Insurance simply means transferring risk to a well-capitalized entity that specializes in managing those risks.
My guess is you may already be insuring against some of these risks below:
- Premature death
- Chronic Illness/Injury
- Protection from Lawsuits (state-dependent)
- Buffering against future higher taxes (more below)
- Buffering against volatility in retirement (more below)
Can you tell me why transferring these risks off your balance sheet is such a bad thing?
“Creek, creek, creek” say the crickets. 
Let’s face it. Everyone wants the protection, but nobody wants to pay for it.
(Spoiler alert: Oftentimes he benefits of a properly designed IUL policy far outweigh the costs, and the early cash value accrues so early that if for some reason you wanted to exit you could do so for a profit).
I get it. Our team can help quantify the cost/benefit analysis of a custom-designed policy for your situation. That way, you can see for yourself if the benefits are worth the costs.
IUL’s fees often pale in comparison when simply considering all the future taxes embedded in taxable savings account or brokerage accounts.
Don’t forget that it’s the insurance component that makes this possible. So even though we’re not allowed to say “free insurance”, you can say the tax savings certainly subsidizes Indexed Universal Life’s protective benefits.
Summing Up If IUL is a Bad Investment
It really depends on how you look at it. If it’s an all-or-nothing conversation, traditional investments will likely outperform IUL on any multi-decade timeframe.
The financial media and pundits promoting their investment-only approaches will take this one-dimensional viewpoint and beat that horse long after it’s dead, instead of discussing both the pros and cons of Indexed Universal Life, especially when compared with other life insurance products.
Once you fully understand the strategic application of insurance products to optimized retirement planning, you realize their comparisons are apples to oranges.
Also, once you get into retirement planning, you realize that rate of return is but one lever in a complex machine that dials in a successful retirement plan or not. The sequence of returns that make up the average are much more important, not to mention withdrawal rate, drawdown rate, and tax rates, all of which should be considered for an optimized retirement withdrawal strategy.
Indexed Universal Life has a unique retirement utility with both risk management and tax-efficient withdrawal strategies. Put another way, retirees can opt for more aggressive withdrawal rates than the infamous 4% if they have a volatility sponge and tax eraser like IUL.
Lastly, cash value is simply a savings component built into an insurance policy. Before considering doing an IUL vs. your 401(k) or an IUL vs. a Roth IRA, you should first consider redeploying idle cash to use life insurance as your own private bank.
There are just too many unique uses to simply dismiss IUL as a bad investment. Definitely do your own research and consult with qualified professionals before implementing any advice here that is intended to be for educational use only.
John “Hutch” Hutchinson, ChFC®, CLU®, AEP®, EA
Founder of BankingTruths.com
John “Hutch” Hutchinson is the founder of BankingTruths.com, an educational site discussing how to maximize the lifetime benefits of both Whole Life Insurance and Indexed Universal Life Insurance by creating your own private family banking mechanism.
Information presented in this article by John “Hutch” Hutchinson is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities product, insurance products, financial services, or investment strategies. Be sure to first consult with a knowledgeable, ethical, and licensed insurance professional before implementing any strategy or product discussed herein.
