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Beth Pinsker: Indexed universal life insurance may be the right choice for some people – but probably not you

Everywhere you turn, somebody is probably trying to sell you indexed universal life insurance — financial advisers, TikTok influencers, news channel commercials and even your company’s benefits team. These policies are marketed as a solution to all your financial frustrations, like access-restrictions on 401(k) policies, the taxation of Social Security and Medicare benefits, the high cost of long-term care and the slow, boring process of compound investment growth. 

Can you really make a guaranteed, tax-free 15%-plus return with no strings attached and still have money left over when you die, as some claim on TikTok videos? 

Probably not. But a lot of people are buying into the claims, and policy sales are spiking. Insurance companies sold nearly 450,000 indexed universal life contracts in 2022, for a total of about $2.7 billion in premiums, says Wink Inc. Chief Executive Sheryl J. Moore, an independent analyst who tracks life insurance sales. Sales have picked up consistently over the past 10 years — in 2011, premiums were less than $1 billion. 

“They say it’s the panacea to all financial needs. It sounds too good to be true. It can happen like that, but the chances are really low in my opinion,” says Andy Panko, a certified financial planner based in New Jersey who is running a detailed analysis of IUL based on his own policies and others. 

Most policies in force today have been in effect only a few years, and the longest ones not much more than 10 years. “The longest I’ve seen personally is 12 years,” says Kevin Lao, a certified financial planner based in Jacksonville, Fla., who has investigated the policy details of many IULs. “It’s not very tested, and there’s not a lot of longevity.”

That leaves a lot of the claims about death benefits and long-term care unproven. So too, the illustrations about the growth of the policies. Unlike stocks and other equities, which are strictly regulated to prevent making claims about growth, IULs can be marketed with long-term projections. Some of these show sustained growth in the range of 9% to 15%. In reality, Panko and Lao are seeing average returns around 5%, more in line with traditional bond returns than the S&P 500, on which most of the policies are based. 

What are you buying? 

At base, indexed universal life is like any other permanent life insurance policy: You pay in premiums over time and your heirs will get a death benefit when you die, and it doesn’t run out in 10 or 20 years like term life insurance. 

The difference with these policies is that they have a cash-value feature where your account is aligned against an index, usually the S&P 500. The money is not directly invested in the market in your own account, like it would be in a 401(k) or IRA, but you are credited for a certain amount of growth each year, more like an interest payment. IUL policies typically have a floor of zero, meaning that even if the index goes negative, your cash doesn’t lose value. But there are also caps, these days around 9% but they could be as high as 12% or as low as 6%. Plus, the caps can change on existing policyholders over time at the discretion of the issuer. 

Lao has seen one individual with policy for five years and they already changed the cap on him. “He’s not happy,” Lao says. “Overall, he’ll keep the policy because he’s not insurable anymore because of a health situation. He’s stuck with this thing.”

With IULs, you can take loans against the cash value, and that money is not counted as taxed income. The insurance policy is the collateral, much like you would borrow against your house for a home equity line of credit. You can also get a long-term-care rider and use the cash value built up in order to pay for medical needs. Because this is a life insurance policy and not an investment, the tax treatment is one of the key features that gets touted by IUL enthusiasts. A death benefit is not taxed, and so the cash you take out as loans against it is not taxed as income either — contrary to a distribution from a tax-deferred retirement account. 

You can also avoid that pesky 59½ age restriction on distributions, and required minimum distributions (RMDs) from tax-deferred accounts after age 73. Some promoters even talk about avoiding Medicare IRMAA surcharges for high-income individuals: by taking loans instead of RMD distributions, you could presumably lower your income below the government’s means-testing thresholds. 

But the catches: If you use any of these cash-out features, you will, first of all, lower your death benefit. There are also fees and other charges, especially within the policy’s surrender policy, which could be 10 years or more. And there are ways in which the loans end up taxable. You can very quickly get into trouble with these policies. 

“I see some ads and Facebook groups and such talking about a tax-free retirement account. But tax-free is far from the truth,” says Panko. “You can take out up to the amount you paid in, taking back your own money. But if you withdraw more than what you put in, it’s fully taxable.”

The sweet spot for IULs

So who should buy IULs? Somebody who needs life insurance. Period. 

“The reality is that you’re buying a life insurance policy. The reason to buy a life insurance policy is to get a life insurance policy,” says Lao.

That, however, is not why most people are buying IULs, thanks perhaps to the marketing pitches. Moore says almost 80% of people buying did so for the cash accumulation feature, according to her company’s tracking, while only 7% bought because of the death benefit. That contrasts to the reasons why people buy universal and whole life policies, which is primarily for the death benefit. Only 15% of those buying universal life did so for the cash accumulation. 

David McKnight, a financial planner and author of “The Power of Zero,” who sells IUL policies and explains them in detail on his YouTube channel, says the best use case he sees for indexed universal life is people over age 50 who are looking to shield themselves from long-term care risk. However, he has not actually seen this in action yet.

“I’ve been selling IUL for the last 11 years, so if you were looking at couples that were 50 and 60 then, they’re 60 and 70 now. None of those people have had to use long-term care yet,” McKnight says.

That becomes a big caveat when you consider that you are buying these policies some 20 or 30 years before you might need care, and the whole industry could go sideways. Just look at the trajectory of the traditional long-term-care market, which has flatlined in the past few years because policies became too expensive for companies to maintain. “Actuaries are good at predicting these things from the death benefit standpoint. They weren’t so good at the long-term-care part of it,” says McKnight. 

The real sweet spot for IUL sales might be people like Moore, or maybe even just Moore herself, as an expert in all types of insurance policies who has a need for multiple policies as a small-business owner. Moore also owns whole life and universal life policies, but uses IULs as key person insurance on all her employees, plus her husband and kids. Her oldest contract is 20 years old, and was originally capped at 12%. “There have been years I’ve earned 12%, and also years I’ve earned zero. I’ve averaged about 7%,” she says. 

“I will tell you that in my experience with IUL, most people selling it are doing a good job. But there are a lot of people who do not properly understand how it works — but think they do — and therefore are not doing their clients a service.”

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