In recent years, a growing number of young people have become interested in Indexed Universal Life (IUL) insurance policies. Often marketed as a combination of life insurance and investment, these policies promise the potential for growth within the policy that policyholders can access while alive, unlike traditional term life insurance. However, financial experts, including Dave Ramsey, have raised significant concerns about the costs, risks, and overall benefits of IUL policies, arguing that they may ultimately be financially harmful due to high fees and complex cost structures that undermine their value.
In this article we’ll go through why IUL is a bad investment and what you should invest your money into instead.
The Allure of Indexed Universal Life (IUL) Insurance
IUL insurance policies differ from traditional term life or whole life insurance in that they are linked to a stock market index (such as the S&P 500). Policyholders can potentially see growth in their cash value, a feature heavily emphasized by insurance marketers who suggest that IULs offer both life insurance and a way to build wealth. This dual-purpose angle makes these policies particularly attractive to younger people looking for flexible financial products that blend protection and investment potential.
Insurance companies and agents often present IULs as a modern financial tool, suggesting that they allow policyholders to “use life insurance while still alive.” They highlight the policy’s cash value component, which, depending on market performance, could grow over time and theoretically provide financial security while the insured is still alive. The idea of accessing this accumulated cash value appeals to those who may feel uncertain about the stock market but still want a vehicle for long-term financial growth.
The Hidden Costs and Risks of IUL Policies
Despite the appealing marketing, critics argue that IULs come with high costs and complicated structures that often work against policyholders. Ramsey points out that the policy’s premiums, which include a portion for insurance and a portion for investments, become increasingly costly as the insured ages. Unlike term life insurance, which has fixed premiums for a set term, the cost of maintaining an IUL rises annually. This is because the insurance component of an IUL is based on an “annual renewable term” structure, which means that every year, the cost of coverage increases as the policyholder gets older. Over time, more and more of the policyholder’s premium goes toward covering the insurance portion rather than the investment.
This gradual shift can leave IUL policyholders with little to no cash value in their policy, and they may have to draw on their accumulated savings just to keep the policy active. This phenomenon, often called the “upside-down” effect, happens when the policy’s internal costs outpace its cash value growth, ultimately eroding its value from within.
Comparing IUL Policies with Term Life Insurance
Ramsey and other financial experts generally advocate for term life insurance as a more affordable and straightforward alternative to IUL. Unlike IULs, term life insurance policies have fixed, lower premiums and do not contain a cash value component. While term policies do not accumulate any value or allow borrowing against them, they offer affordable, guaranteed coverage over a specific period, typically 10 to 30 years.
The primary advantage of term life insurance is its simplicity and low cost, which allows policyholders to save or invest the difference in premium costs. Ramsey suggests that young people consider purchasing a term life policy and separately investing the savings from lower premiums in higher-yield investment options, such as a Roth IRA or other diversified investment portfolios. This approach, he argues, avoids the pitfalls of the IUL’s high fees, complex structures, and unpredictable returns while still enabling wealth-building through direct investment.
Why IUL Policies May Not Be Ideal for Young Investors
While IUL policies can appeal to younger individuals seeking a hybrid of life insurance and investment, the fees and ongoing costs can make it an inefficient way to build wealth. The increasing cost of the insurance component, combined with high commission rates for agents, can mean that policyholders see less benefit from their premiums over time. Additionally, because the cash value growth is tied to stock market indexes and capped by participation rates, the investment portion of IULs may deliver limited returns compared to direct investments in mutual funds or retirement accounts.
Here are a few reasons why IUL is a bad investment:
1. High Fees and Commissions
IUL policies come with numerous fees, including administrative fees, cost-of-insurance charges, surrender charges, and fund management fees. These can significantly erode the policy’s cash value over time. Additionally, IUL policies typically pay high commissions to agents, which are funded by premiums, reducing the amount actually invested in the policy’s cash value component
2. Increasing Costs Over Time
Unlike term life insurance, which has fixed premiums for a set period, IUL policies have premiums that often rise each year as the insured ages. This is due to the “annual renewable term” component, where the cost of insurance increases as the policyholder gets older. Over time, the increasing cost of maintaining the insurance can consume much of the policy’s cash value. This “cost of insurance” feature can lead policyholders to pay more out of pocket to keep the policy active, especially in later years
3. Limited Investment Returns
IULs are linked to stock market indexes, like the S&P 500, but they typically come with “participation rates” and “cap rates” that limit the policyholder’s potential returns. A participation rate restricts the percentage of the index’s gains that apply to the policy, and cap rates set a maximum return the policyholder can earn, regardless of how well the index performs. As a result, policyholders often receive lower returns than they would with direct investments in index funds or other stock market options
4. Complexity and Lack of Transparency
IULs are notoriously complex. Policies include intricate details about fees, caps, participation rates, and the annual cost of insurance. Understanding how these affect the policy’s cash value and overall benefits requires careful reading and often an in-depth understanding of insurance and investment concepts. This complexity can lead to misunderstandings, with many policyholders not realizing how much of their premiums go toward fees rather than investment growth.
Why IUL is a bad investment?
For young people interested in building wealth alongside life insurance, financial experts recommend carefully considering the implications of IUL policies and exploring alternatives that may offer more control and transparency. While IUL policies provide the appeal of combining insurance with investment potential, their hidden fees and escalating costs can limit their long-term value, potentially leaving policyholders with less security than they anticipated.
Ultimately, a straightforward term life insurance policy combined with separate, high-yield investments can offer both financial flexibility and long-term growth without the complications and costs associated with IUL policies. Alternatively check out our advice on the best way to invest your money.