Is Indexed Universal Life Insurance a Scam?

This week, the sun started rising before 7 AM where I live. The days are getting longer. The weather is getting warmer. The spring is springing, and I am excited.

No. At the end of the day, it is difficult to find a true scam in the highly regulated insurance markets. However, the devil is in the details, and life insurance salesmen may overinflate or intentionally misrepresent certain aspects of Indexed Universal Life Insurance (IUL). The actual policy is not a scam, but the salesmen might be less than honest. 

If you’re just joining us or forgot some of the big concepts of life insurance, check out Mike’s letter on Whole vs. Term Life Insurance. 

IUL is a type of universal permanent lIfe insurance which means it lasts until you die (or stop making payments) and has a cash value associated with the policy. There are three types of universal life insurance with the main difference being what happens with your cash value. Let’s break them down:

• Fixed: Your cash value grows at a fixed (small) rate

• Indexed: Your cash value grows with the stock market up to a certain amount but doesn’t shrink

• Variable: Your cash value grows and shrinks with the stock market

No matter what option you chose, the salesman gets his or her cut, just like Bowser in Mario Party. Some options are better for you, some are worse, all options pay the salesman first. 

Off the bat, you are probably thinking, “Indexed is the way to go! My cash grows but doesn’t shrink!” There are a lot of caveats to indexed policies:

1. Your cash isn’t actually invested in the stock market. The insurance company invests in other vehicles like options or funds then adds the gains to your value. The negative to this is you don’t receive any dividends that you would receive if you invested directly into an S&P 500 ETF. 

2. They protect you from losses by taking additional gains. Depending on your policy, the cap on gains might be 8-12%. Which may seem very respectable, but that is not your actual increase in value due to the participation rate.

   1. The participation rate is the amount of money in your cash value that is actually ‘invested’ into your chosen index. Depending on your policy, it will almost always be less than 100%. They can vary from 25% to over 100%, but that is only in rare situations for expensive policies that the insurance company doesn’t think will last very long.

   2. Let's say you have a $100,000 cash value in an IUL with a 75% participation rate. If your cash value grows to the cap at 12%, you might be really excited thinking the value grew by $12,000. In reality, it only grew $9,000 or 9% of the total cash value because only $75,000 of your $100,000 is ‘invested’ due to the participation rate. The lower your participation rate and growth cap are, the worse your real return will be. 

3. It takes a very long time to grow your cash value. Mike talked last week about the ‘infinite banking’ system that capitalizes on loans against your cash value, but he also detailed how difficult it is to get a large cash value. Every month when you pay your premium, your money is divided many ways:

   1. Fees and Commission: your salesman and company gets their share of your payments.

   2. Death Benefit: the next part goes to guaranteeing the death benefit.

   3. Cash Value: the final portion, if there is any left, goes to your cash value and gets invested. In most cases, it takes two to five years of premium payments before any of your contributions go toward your cash value.

An IUL does have a few benefits that I must mention so you know what salesmen will try to inflate when pitching you.

1. An IUL policy offers a death benefit that is exempt from death taxes. If you are getting a life insurance policy, the primary reason should be to provide security for your loved ones in case you die. Every other benefit is far too expensive to be worth it unless you need the additional insurance protection.

2. Your cash value does grow tax deferred like a Traditional IRA. Since there is no cap on how much you can contribute each year, an IUL lets people lower their taxable income. This also means you pay more and more to your salesman. If you are already maxing out your IRA and 401(k), then an IUL may provide some additional tax benefit. You should run the numbers to determine if your tax deferral will beat the amount of money you pay in fees and commissions. Also, don’t forget that you will have to pay taxes on the cash value eventually. 

3. Your premium can be adjusted. Unlike other policies with fixed premiums, you can increase or decrease your annual premium. If you decrease your premium too much though, you may have a lapse in coverage or lower your cash value to cover the fees and death benefit. Increasing your premium allows you to put more money to your cash value (and the salesman’s pockets). 

Indexed Universal Life Insurance policies provide peace of mind with a death benefit and the potential for limited gains (and no losses) from stock growth.

I am against permanent life insurance because the costs far outweigh the benefits. The alternative is a term life insurance policy (much cheaper) until you are 65 combined with maxing out a 401(k) and IRA. If you are under 50, that means $30,000 (2024 numbers) per year invested into retirement accounts. This allows you to prepare for retirement, provide security for your family while still working, and keep as much money for yourself as possible.

Mike and I want to be the bain of life insurance salesmen. I dream that one day life insurance salesmen will start their pitch with “Do you read the Dollar Debrief?” When you answer “yes,” they leave you alone.

Call to Action

Any talk of 401(k)s and IRAs is always a good time to review if you are maxing out these amazing retirement vessels. If you are not, see if you can increase your contributions by 1%.

What We’re Reading/Listening To:

Stick Season by Noah Kahan. This album and song have been all the rage for a while now. I still can’t get enough of it. The entire album is fantastic even though he doesn’t sing about ETFs.

Debrief on Deck

Next week, Mike will dive into saving for children’s college expenses. I am excited because based on my athleticism, my kids won’t be getting any athletic scholarships. So I think I need to get a jump start.

As always, please reach out to us with any questions or comments you have. You can reply directly to this email or find us on social media (X (formerly Twitter) and Instagram).

Until then, stay the course.

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