Why is IUL a Bad Investment: Is it really?

IUL isn’t an investment at all, it’s an insurance product. But, it does have unique growth, risk, liquidity, and tax characteristics that can help bolster a traditional retirement portfolio.

Don’t worry, I’m not here to insult your intelligence with simpleton statements like “Let investments be investments, and insurance be insurance.” This axiom falls flat since traditional financial planning has left Americans less prepared than ever for retirement.

Why influencers say IUL is a bad investment

I’m also not going to wax on and on about how IUL is some cure-all panacea for these financial woes.

Both these opposing opinions above miss the true essence of whether or not IUL is a bad investment for people considering IUL vs. their 401(k) or IUL vs. a Roth IRA.

Indexed Universal Life has a unique set of pros & cons and is just way too complex of a product for it to be that simple. Also, IUL can produce additional benefits above traditional savings accounts while opening up retirement withdrawal strategies by taking pressure off of traditional investments.

Unlike the noisy pundits, notice how we discuss value creation by coordinating insurance with traditional financial planning. Strategic coordination is the key, not yelling about your preferred strategy or polarizing “this vs. that” arguments.

That’s the problem with the financial media saying IUL is a bad investment. Everyone naturally has an agenda to promote their own wares, and it’s much easier to gain attention when using hate or hype for hook value.

This practice of investment advisors bashing insurance agents and vice versa has been happening for eons because both industries have been battling for the same client dollars. Unfortunately, it’s the client who loses out amidst the confusion.

I’ve got news for you…Neither investments nor insurance are as powerful in isolation without some of the other offerings to complement its own shortcomings.

Table of Contents

Why IUL is Considered a Bad Investment

  • What makes Indexed Universal Life a bad investment is ironically its protective 0% floor. This hedging mechanism used by insurance companies does indeed erase any stock market losses from IUL, but it also substantially limits its upside in bull markets.

The S&P 500’s raw returns have undeniably outperformed Indexed Universal Life in any multi-decade timeframe. IUL simply can’t compete with index funds unless it substantially increases its exposure to stock options, which would in turn subject the policyholder to much more downside risk.

The S&P 500 Index is perceived as both a pro and con of Indexed Universal Life insurance. Most IUL policies track the S&P 500 Index on it's way up without realizing any losses from market downturns
  • 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.

Either Indexed Universal Life or Whole Life insurance has unique implications for an optimized retirement withdrawal strategy in terms of both risk management and tax efficiency. We’ll discuss this further below, but people often don’t put every dollar into their riskiest investments, correct?

Let’s first talk about how Indexed Universal Life insurance may be a better savings vehicle than low-yielding taxable bank accounts.

IUL is not an Investment, but Insurance with a Savings Component

Indexed Universal Life isn’t an investment at all, but an insurance policy with a savings component. You hear all the pundits promoting investments parroting this same mantra about IUL as if it’s a bad thing.

IUL is Insurance at its Core

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’re already insuring against some of these below. If not, you may be over-exposed to these risks:

  • 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 🦗🦗🦗.

IUL’s Cash Value is a Savings Vehicle

Tied to IUL’s insurance component is this savings component called cash value. Let’s look into that:

We know intrinsically not to “put all our eggs in one basket” when it comes to picking mutual funds in our 401(k). Otherwise, you wouldn’t pick index funds investing in 500 different stocks. You’d literally just put every penny you had into Amazon or Apple all the time, but why don’t you?

Declining interest rates can dramatically change which indexed universal life companies put out the best performing IUL products

It’s called diversification. This is also why you keep some safe money sitting in low-to-no yield savings account exposed to annual taxation, right?

Again, if you read enough from insurance haters, they’ll tell you that the cash value component of any permanent life insurance product is just a savings component.

We agree!

So if clients already have savings accounts anyway, why don’t we reengineer insurance products to make this savings allocation more efficient like major banks do themselves

Here’s how IUL cash value improves upon traditional savings accounts:

  • Historically better growth rates
  • Tax-Deferral on any credited interest
  • Built-in hedges in the form of insurance
  • But does require ongoing, but flexible contributions

Furthermore, how Indexed Universal Life’s cash value differs from Whole Life is:

  • Policyholders can choose a fixed rate (declared monthly or quarterly)… or
  • They can forgo this fixed rate and choose from different indexed crediting strategies

You can learn more about how Indexed Universal Life works as well as IUL’s pros and cons in our in-depth article.

Does IUL work with Infinite Banking?

Indexed Universal Life can indeed work for infinite banking. However, it must be 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 ideal since infinite banking entails borrowing for major expenditures and strategic investment opportunities.

The best performing IULs from the top companies of 2018 have multiple was to grow your cash value and create tax-free income for retirement

Even though Indexed Universal Life provides more stability than mutual funds, it’s still somewhat correlated to the market. Some of the best times to aggressively borrow against IUL for infinite banking would be when the market is bleeding. Down markets may last for multiple years of 0% crediting, whereas Whole Life would be growing each year no matter what.

Check out our in-depth article on IBC to learn everything you ever wanted to know about how the infinite banking concept works.

Another reason why people think IUL 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 and Retirement Planning

Diversification is retirement planning’s biggest buzzword. Everyone knows to buy a diverse set of stocks or mutual funds so as not to put all their eggs in one basket. The problem with this stale view of diversification is that global market sectors are now more correlated than ever due to technology and globalization.

I got some bad news, most of you still have all your eggs in the same basket despite having different account types with different fund symbols inside.

Let me ask you, “What if IUL could better help hedge an overall portfolio against market downturns as well as future higher taxes so your retirement withdrawal strategy doesn’t drawdown your account as much?”

That’s essentially what life insurance products like both IUL and Whole Life can do for you. They add different dimensions to your retirement withdrawal strategy that can better help with:

  • Increasing your portfolio’s overall withdrawal rate
  • Sequence-of-returns risk during withdrawals
  • Future higher tax risk in retirement
  • Chronic & critical illness care
  • Untimely death

It’s possible that Whole Life’s guaranteed death benefit may also be able to help with longevity risk in a way that Indexed Universal Life cannot. Be sure to check out how Whole Life and Indexed Universal Life help retirement.

IUL vs. 401(k)

Rather than ask, “Should I do an IUL or invest in my 401(k)?” perhaps you should instead be asking, “How much should I allocate to IUL vs. a 401(k)?”

Unfortunately, the polarizing mentality of the financial media leads you to believe that it’s an either/or proposition between starting an IUL or contributing to your 401(k).

Guess what, it’s not.

Here’s another way to look at the whole IUL vs. 401(k) dilemma. Maybe you should reframe the question as “When should I contribute to an IUL vs. my 401(k)?”

Since Indexed Universal Life is both age and health sensitive, starting any life insurance policy sooner rather than later is generally better.

That being said, we believe in contributing at least enough to your 401(k) to get a company match. Contributing pre-tax dollars past the 401(k) company match is not only inefficient but could actually be quite dangerous as it exposes you to future higher taxation.

Why do a 401(k) delay for modest income earners:

You’re likely in one of the lowest tax brackets you’ll ever be in again. There are over 32,000,000,000 reasons why the federal government will need to raise taxes on everybody at some point in the future.

Even if they don’t, do you think you’ll be making more or less money as you get older? Hopefully more money, right?

This means any taxes you pay this year by not contributing to your 401(k) over and above the company match is almost like paying your taxes on sale now, rather than kicking that can down the road.

What about high income earners?

When people have income pushing them into the higher tax brackets and/or they are in high-tax states, it may actually make sense for them to max out their 401(k). This is especially true if they plan to have multiple diversified income sources in retirement. If so, they may be able to limit the income stream in retirement from their 401k so that it absorbs the lower, more favorable brackets.

Guess what! IUL helps high earners achieve this.

Having either Indexed Universal Life or Whole Life naturally provides a bucket of tax-exempt assets in retirement. High earners can surgically pull from these products in retirement without subjecting that withdrawal to their highest tax bracket.

Many of you may be asking if this can also be accomplished with a Roth IRA vs. an IUL, so let’s discuss that too.

IUL vs. Roth IRA

Should someone do an IUL or a Roth?

In general, people shouldn’t do an IUL instead of a Roth. However, they may want to consider having both. Even though a Roth or IUL both offer tax-free withdrawals, an IUL or Whole Life policy can better supplement retirement income during market downturns since they are much less correlated than a Roth.

When markets are bleeding is the worst time to pull from your Roth since ideally, you’ve invested for your highest growth potential here. Usually, this translates to bigger losses in a down market.

It’s ideal to pull from your Roth IRA when markets are frothy so you can redeem fewer total shares to create tax-free retirement income. In theory, when markets are down you should let your Roth heal rather than redeem more shares to produce the same income.

Having an IUL or Whole Life as a “volatility sponge” makes this possible.

When funding an IUL for this purpose, you shouldn’t be thinking that Roth vs. IUL is an either/or proposition. We recommend funding IUL, not using Roth contributions, but by redeploying idle cash or the bond portion from your 401(k).

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.

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 average are much more important, not to mention withdrawal rate, drawdown rate, and tax rates, all of which make up an optimized retirement withdrawal strategy.

Indexed Universal Life has a unique retirement utility with both risk management and tax-efficient withdrawal strategies, both of which can hedge against longevity risk by preserving portfolios. 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.

Whole Life insurance actually has additional utility with its additional guaranteed death benefit. You can learn more about Indexed Universal Life vs. Whole Life here.

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
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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.