IUL Explained: Pros, Cons, and Who Should Not Buy One

Indexed universal life, or IUL, is permanent life insurance with a cash value tied to a market index like the S&P 500. A cap limits how much you can gain. A floor, usually 0 percent, keeps an index drop from cutting your cash value. It can fit a high earner who has already maxed other tax-advantaged accounts and will fund it well for decades. For almost everyone else, it is oversold.

IUL might be the most heavily marketed life product on the internet right now. The pitch sounds great: market gains with no market losses, tax-advantaged income, be your own bank. The machinery underneath is more modest than the pitch. I sell these, so I will show you how one really works. Then I will tell you who should walk away. If you finish this and decide it is not for you, that is a win, not a lost sale.

The index is one moving part. Charges and policy assumptions keep moving too.

IUL moving part | What it controls | What to ask for
Premium. | Money entering the policy. | The amount needed under guaranteed and current assumptions.
Insurance charges. | Money removed to support coverage and riders. | The charge schedule and what can change.
Index credit. | Interest under the cap, floor, spread, or participation rule. | The current rule, guaranteed minimum, and change history.
Cash value. | The pool supporting loans and future charges. | Values under lower crediting and missed-payment stress.

What an IUL actually is, and isn't

An IUL is permanent life insurance. It pays a death benefit for your whole life, as long as you keep it funded. Wrapped inside is a cash value account. That account earns interest based on an index, not on stocks you pick.[1]

Here is the part the pitch blurs. Your money is not invested in the stock market. The insurer holds your cash value in its own general account. It buys options that track the index. You do not own the shares. You do not collect the dividends. You get a credited interest rate that comes from the index.[1][2]

So "linked to the S&P 500" is not "invested in the S&P 500." You are buying a formula that references the index. You are not buying the index itself. Almost everything about an IUL comes back to that one difference.

The three dials that control your growth

Three numbers decide how an IUL grows. Learn these and you know the product better than most people being sold one.

The cap is your ceiling

The cap is the most interest you can earn in a set period. If the index returns far more than your cap, you still get only the cap. The insurer keeps the rest. That is part of how it pays for your floor. Caps are not guaranteed. The insurer can lower them later, and they tend to move with interest rates.[2][3] State regulators now limit how high an agent may illustrate these rates, because the older illustrations ran too hot.[3]

The participation rate is your share

The participation rate is the share of the index gain you are credited, before the cap. At a 50 percent rate, a 10 percent index gain credits you 5 percent. At 100 percent, you would be credited the full gain, up to the cap. Rates can change too. A policy can use a cap, a participation rate, or both.[2]

The floor is your safety net, with an asterisk

The floor, usually 0 percent, means an index drop does not cut your cash value from the index side. That protection is the real selling point. But 0 percent is not the same as no cost. Your policy still charges the cost of insurance, admin fees, and rider fees every year.[4] In a flat year, those fees still come out of your cash value. So a 0 percent year can be a losing year for your account. This is the single biggest risk in the product.

Where your premium actually goes

When you pay an IUL premium, it does not all go to growth. It first pays the cost of insurance. That cost rises as you age. It also pays admin and rider fees. Whatever is left goes to cash value, which then earns the index credit.[4] This is why funding level matters so much. Underfund an IUL and the rising insurance cost can eat it from the inside. In a bad case you get a premium call: pay much more, or the policy collapses.[4]

The truth about those illustrations

Every IUL is sold off a one-page illustration. A smooth line climbs for decades at a chosen rate. Understand what that line is. It is a projection based on today's caps and assumptions. It is not a contract, and it is not guaranteed.[3] The insurer can cut the caps. The market will not move in a straight line.

After fees and caps, IUL cash value tends to grow more like a bond than like the stock market.[2][3] That is not a scam. It is what the mechanics produce. You pay for the floor by giving up the dividends and the gains above your cap. That can be a fair trade for the right person. It is a bad trade for someone promised stock returns with no risk. No product pays market returns with zero risk, and anyone who guarantees that is a warning sign.[5]

Who should buy one, and who should walk away

Illustration check | Strong evidence | Warning sign
Guaranteed column. | It is shown beside the current projection. | Only the higher projected line is discussed.
Lower-return test. | The policy remains clear under a modest crediting rate. | The design needs a high rate to stay in force.
Funding plan. | The premium fits a bad income year. | The plan uses the smallest early payment.
Loan test. | Interest and lapse risk are modeled. | Loans are called free or self-paying.

It can fit if you:

Have already maxed your 401(k), IRA, and HSA, and want another tax-advantaged bucket.[6]

Have a real need for lifelong coverage and want some index-linked upside with a floor.

Will fund it well and consistently for decades, not at the bare minimum.

Accept bond-like expected growth in trade for that floor.

Walk away if you:

Have not maxed your basic tax-advantaged accounts yet. Do that first. It is simpler and usually better.[6]

Are being sold it as stock returns with no risk, or as guaranteed tax-free income. That is the oversell.[5]

Cannot commit to funding it well for the long haul. An underfunded IUL can collapse.[4]

Just want simple, steady cash value. A whole life policy is more predictable.

An IUL is a real product, not a scam. For a high earner who has maxed everything else, wants permanent coverage, funds it well, and expects bond-like growth, it can be a smart piece of a plan. But it is oversold to people it does not fit. If someone pitches market gains, no losses, tax-free, for everyone, you are hearing a script.[5] Want the simpler cousin? Compare it with whole life. Not sure you need permanent coverage at all? Start with term versus whole life. Before you sign, run these questions to ask a financial advisor. And to see what the same money might do in plain index funds, look at investing $300 a month.

Common questions

Is an IUL a good investment?

An IUL is life insurance first, not an investment. Regulators class most IUL as insurance, not a security.[1] After fees and caps, its cash value tends to grow more like a bond than like stocks.[2] It can fit as a tax-advantaged bucket for someone who has maxed other accounts. It is a poor fit if you mainly want simple market growth.

Is IUL tax-free?

Not exactly. The death benefit is generally paid income-tax-free to your beneficiary.[7][8] The cash value grows tax-deferred. You can often borrow or withdraw from it without current income tax, if the policy is funded within federal limits and stays in force.[9] Overfund past the seven-pay limit and it becomes a modified endowment contract, which loses that treatment.[10] Let the policy lapse with a loan still out, and you can owe tax. So it is tax-advantaged, not tax-free.

Does an IUL premium increase?

The premium can be flexible, but the cost of insurance inside it rises as you age.[4] If you pay only the minimum, that rising cost can outrun your cash value. Then you face a premium call: pay more, or lose the policy. Funding above the minimum is what keeps it stable.

Who should not buy an IUL?

Skip it if you have not maxed your basic tax-advantaged accounts, cannot fund it well for decades, or were sold it as risk-free market growth.[5][6] Most people who need coverage are better served by term insurance plus investing the difference.

This is general education, not tax, legal, or investment advice. IUL illustrations are hypothetical and not guaranteed. Caps, participation rates, and charges vary by company and can change. Any guarantee depends on the issuing company's ability to pay claims. I am a licensed insurance and financial professional, and I can be paid when someone buys a policy. I say so because knowing how your advisor is paid is part of judging any advice, including mine. Review your own situation, and the full policy illustration with its guaranteed and non-guaranteed columns, with a qualified professional before acting.

Sources

FINRA, "Insurance". Accessed July 27, 2026.

FINRA, "The Complicated Risks and Rewards of Indexed Annuities". Accessed July 27, 2026.

National Association of Insurance Commissioners, Actuarial Guideline XLIX-A (indexed universal life illustrations). Accessed July 27, 2026.

National Association of Insurance Commissioners, "Life Insurance Buyer's Guide". Accessed July 27, 2026.

Federal Trade Commission, "Investment Scams". Accessed July 27, 2026.

U.S. Securities and Exchange Commission, Investor.gov, "Insurance Products". Accessed July 27, 2026.

Legal Information Institute, 26 U.S. Code § 101 (certain death benefits). Accessed July 27, 2026.

Internal Revenue Service, "Life Insurance & Disability Insurance Proceeds". Accessed July 27, 2026.

Legal Information Institute, 26 U.S. Code § 72 (annuities; certain proceeds). Accessed July 27, 2026.

Legal Information Institute, 26 U.S. Code § 7702A (modified endowment contract defined). Accessed July 27, 2026.

Federal Reserve Bank of St. Louis (FRED), 10-Year Treasury Constant Maturity Rate. Accessed July 27, 2026.