Indexed Universal Life (IUL) Insurance Explained: What It Is and How It Works

Indexed Universal Life (IUL) Insurance is often marketed as a product that can both protect a family’s financial future and participate in market-linked growth without losses. While that story sounds appealing, the reality is more nuanced.

According to Insurance Journal News, IUL new premiums totaled $3.9 billion in 2024, a 4% increase from the prior year, with policy counts up 10%. In the first quarter of 2025 alone, premiums grew 11% to $959 million, with policy counts up 7%. Much of this growth has been fueled by messaging that emphasizes market-linked upside with limited downside, though the details tell a more complex story.

An IUL combines lifelong insurance protection with a cash value account that credits interest tied to an index like the S&P 500. However, credited growth is subject to caps, participation rates, and ongoing fees. This article explains how IULs function, the mechanics that shape their returns, and when they may—or may not—be a fit compared to simpler options.

Key Takeaways

• IULs combine permanent life coverage with cash value linked to an index, but subject to participation and cap limits.
• Credited returns do not mirror the index; they depend on policy terms.
• Administrative charges can reduce long-term growth.
• IULs may support certain tax or estate planning goals but are not a universal solution.

How IUL Insurance Functions

At its core, an IUL provides two elements: a death benefit for beneficiaries and a cash value account that grows based on index-linked interest. Importantly, the cash value is not invested in the index itself. Instead, the insurer credits interest using a formula that reflects index performance.

Two features determine how much is credited:

• Participation rate – The percentage of the index return applied. For example, at 80%, a 10% index return credits 8%.
• Cap rate – The ceiling on credited interest. If the cap is 9% and the index returns 12%, only 9% is credited.

Most policies also include a floor rate, often 0%, which prevents negative credited interest. However, annual fees can still reduce the account in down years.

Comparing IULs to Other Permanent Coverage

Relative to whole life insurance, IULs offer more flexibility but less predictability. Unlike variable universal life (VUL), where cash value is invested in subaccounts, IUL cash value isn’t directly in the market. This helps avoid full market losses but also caps potential gains.

• Why it matters: Understanding these contrasts helps clarify whether an IUL aligns with personal goals—such as preferring steadier growth or being comfortable with capped, index-linked returns.

Common Misunderstandings About IUL

Despite their popularity, IULs are often surrounded by misconceptions:

• Myth: IULs deliver market-level returns.
  Reality: Credited interest is shaped by caps, participation, and formulas—it never mirrors the index directly.
• Myth: A 0% floor guarantees no loss.
  Reality: While interest may not be negative, ongoing policy charges can still reduce cash value.
• Myth: Contract terms stay fixed.
  Reality: Insurers may adjust caps or participation rates within contract limits, altering credited growth.

Hypothetical Example: Jane and Tom purchased an IUL, believing it offered strong gains without risk. Over time, rising fees and lowered participation rates reduced their growth. Their experience illustrates why it’s critical to understand all terms upfront.

Proceed with Caution

Indexed Universal Life (IUL) insurance is often promoted with bold claims that overstate benefits and minimize risks. Marketing materials may frame these products as offering stock market growth without downside, tax-free retirement income, or even policies that “fund themselves.” In practice, the reality is far less generous. High fees, shifting contract terms, and performance limits frequently lead to disappointing results—and in some cases, policies collapsing altogether.

Misleading illustrations and projections

Sales presentations often lean on overly optimistic assumptions. Illustrations may highlight returns based on strong bull-market periods, giving the impression of steady long-term gains. At the same time, they may underplay risks such as market downturns or the fact that a “0% floor” still results in no credited growth during bad years, while fees continue to reduce the account value. Non-guaranteed columns in illustrations typically look attractive, but the guaranteed projections often show much slower or even negative cash value growth.

Hidden fees and rising costs

Every IUL includes multiple layers of charges, many of which are not obvious at the time of sale. The cost of insurance increases with age and can eventually overwhelm the cash value if funding is insufficient. Premium loads skim a percentage off the top of each payment, while administrative fees and optional rider charges further eat into returns. For policyholders who surrender early, surrender charges can lock in losses for 10 to 15 years.

Limits on growth

Despite being linked to market indices, IULs are not stock market investments. Insurers impose cap rates (maximum credited returns) and participation rates (a percentage of index gains applied to the policy). Even in strong years when the S&P 500 posts double-digit growth, caps can limit credited interest to a fraction of that. In addition, dividends are excluded from index calculations, cutting out a major source of long-term stock returns.

The “be your own bank” pitch

One of the most common selling tactics is the promise of tax-free retirement income through policy loans. While loans can provide access to cash, they are essentially advances against the death benefit. Any unpaid balance reduces the payout to beneficiaries, and if loans exceed the cash value, the policy may lapse, potentially triggering a large, unexpected tax bill.

Complexity and Cost Considerations

Evaluating an IUL requires factoring in multiple expenses, including:

• Administrative charges
• Insurance costs (which typically rise with age)
• Rider fees for optional benefits

Over the years, these expenses can erode the cash value, particularly when the interest credited is low. Some policies also allow loans or withdrawals, but unpaid amounts reduce the death benefit.

• Hypothetical scenario: A policyholder pays $20,000 annually into a $500,000 policy. If projected crediting rates of 6–7% fall short due to lower caps or higher fees, both the cash value and the longevity of the death benefit may be impacted.

Situations Where IULs May Be Useful

IULs may have value in specific contexts, such as:

• Estate planning, where a permanent death benefit can help offset estate taxes.
• High-income households seeking tax-deferred growth beyond retirement accounts.
• Legacy planning, where providing for dependents or charities is a primary goal.

In these cases, features like flexible premiums and index-linked crediting can be beneficial—provided the trade-offs are understood.

When Simpler Approaches May Work Better

For many, combining term life insurance with a traditional investment portfolio may deliver both protection and growth more directly. This structure separates insurance from investments, making costs clearer and adjustments easier.

So what? If the goal is market-driven growth rather than permanent insurance, an IUL may be more expensive and less efficient than buying term coverage while investing separately.

Choosing an IUL comes down to clarity of purpose. It can be a useful tool in certain scenarios, but it carries complexity and cost. For those considering it, the best step is to weigh it against simpler alternatives, evaluate multiple scenarios, and seek professional guidance to understand both the benefits and limitations.