Index Universal Life (IUL) is the latest product that is being highly promoted as a solution to our retirement financial needs. IUL is a combination of life insurance and a tax sheltered (potentially) cash value account. Interest is credited to the cash value account based upon the performance of an underlying market index. Depending on the policy, you can choose from one or a blend of indices. IUL is the insurance industry’s answer to “buy term and invest the rest”. Here are some of the benefits touted for IUL:

1. Enjoy the upside of the stock market (subject to a cap). A typical cap on these polices is 18%, so if the stock market enjoys a gain of 50% in a year, you will get a maximum of 18% credited to your account. Not the 50%!
2. Avoid stock market losses. If there is a stock market loss in a year, you don’t lose any money. The interest credited in that year is 0%; you won’t incur a loss to your cash value.
3. Potential tax-free growth of the cash value. The cash value is part of the death benefit if you die, which is tax-free to the beneficiaries. You can’t withdraw any gains tax-free but you can borrow from the policy tax-free, subject to following some strict guidelines which are outside the scope of this article.

I have reviewed several illustrations for IUL and here are my concerns:

1. Many of the illustrations I’ve seen assume interest crediting of 8% or more per year, which is highly optimistic. For example, from 2000 to 2002 the stock market experienced losses so you would have had 0% credited to your cash value. I would stress test the policy and use 4% instead of 8% but also consider the “sequence of returns risk” in your evaluation as well.
2. The cost of the insurance increases each year due to the odds of your death increasing each year. These costs need to be paid by further premium payments, the cash value balance or a combination of both.
3. The payback period on these policies can be a decade or longer and they can incur high surrender charges as well.
4. In many cases the cap percentage is not guaranteed and can be adjusted by the insurance company with little notice.

I suggest you avoid IUL. Separate your insurance and investment needs, never combine the two. Insurance and annuities should only be purchased for their contractual guarantees; buy them for what they will do, not for what they might do.