Understanding Indexed Universal Life Insurance (IUL) – Why Is It Good for Retirement Savings?

Thang Truong
Thang Truong
Updated on:

As you try to figure out retirement strategies, you may wonder about Indexed Universal Life Insurance policies (IUL). Is this a good way to save for retirement? Are there tax advantages? Are there any disadvantages to this type of strategy? We’ll break down everything you need to know about investing in IUL policies as a vehicle for retirement. 

What is Indexed Universal Life Insurance?

IUL is a type of permanent life insurance. Permanent life insurance lasts your entire life. IUL lets you build cash value faster and safer than other types of permanent policies because the cash value reflects the performance of the market as a whole. Market indexes include the S&P 500, the Dow Jones Industrial Average, or the Nasdaq Composite. You’re not investing in the market per se, but the interest rate you earn on the account is tied to market performance. 

How does an Indexed Universal Life Insurance Policy Work?

Indexed Universal Life insurance offers both a death benefit and a cash value account. You pay your premiums and some of the money is invested in an indexed account that reflects market performance. This actually mitigates the risk of investing in the market directly. There is a floor on how little interest the account can earn, as well as a cap on how much it can earn. Let’s say you have an IUL account with a cap of 10% and a 1% floor. As we’ve seen lately, the market can fluctuate wildly in uncertain economic times. You are guaranteed to earn 1% on your account, even if the market suffers a downturn. On the other hand, if the market surges and earns 20%, you will earn 10%. 

The average rate of return for the S&P 500 for the past 90 years is roughly 10% (9.8% to be exact). 

A portion of your IUL policy will go towards paying for the death benefit and the rest will be invested to build the cash value. 

Basically, an IUL policy allows you some benefit from a positive market performance while protecting you from losses in a downturn. This is different than a variable universal life policy, which allows you to invest in specific accounts depending on how much risk you can tolerate. Also, learn more the pros and cons of a variable universal life insurance policy.

Use the calculator developed by Amplify below to calculate how much cash value you can take out of an IUL policy when you need it, completely tax-free.


Taking the Money Out of the Cash Value in an Indexed Universal Life Policy

After you’ve built enough cash value in the account, you can withdraw it to pay off your mortgage, help pay for college or supplement your retirement income. A nice advantage to an IUL policy is that you don’t have to be 59 ½ to start withdrawing the money, as is typical for 401(K) and IRA’s. You can withdraw money from a IUL policy at almost any time as long as the cash value account is positive.

Similar to variable universal life insurance policy, you can cash out from your IUL policy by withdrawing or taking out a loan against the cash value account. Withdrawing is always preferred since you don’t have to pay interests, but there is a limit in how much you can withdraw. Loans will incur interests, which is usually paid from the cash value account itself. There are also fees and interests. You can learn the details of withdrawing, loans, interests, and fees when you cash out from your IUL policy here , they are exactly the same as in a variable universal life insurance policy.

Use the calculator developed by Amplify below to calculate how much cash value you can take out of an IUL policy when you need it, completely tax-free.

Case Study of Indexed Universal Life Insurance

Our client is a 42-year old woman named Mary. Mary is in excellent health and has never smoked. She is interested in an Indexed Universal Life policy so that she can supplement her retirement income when she retires at age 60. 

She will invest $6,000 a year from ages 42 to age 60 (18 years), or $500 a month. She wants to be able to withdraw from the cash value on the account from ages 61 to 100, or her death. She will contribute a total of $108,000 to the IUL policy.

This policy has a starting death benefit of $204,632 in year 1 and it is designed for death benefit to increase during the premium-payment years. The policy is called the Accumulation Builder Flex IUL from Penn Mutual. The floor is set at 1.0% and the cap is 9.5%, which is very close to the average earning of the S&P index. By the time she is 60 years old, the death benefit will reach $397,700.

According to the illustration of the policy, Mary can withdraw $13,755 from the time she is 61 up until age 100. In 40 years, her total cash-out from the policy is $550,200, which is 5.1X her total investment in the policy.

As she start withdrawing cash from the policy, death benefit will decrease accordingly. She would still have a death benefit of $61,767 for her beneficiary when she pass away at the age of 100. The death benefit will be more if she passes away earlier than 100 years old. For example, at 90 years old, death benefit will be $168,300.

>>MORE: Case Studies of Universal Life Insurance

What’s an Increasing Death Benefit in Indexed Universal Life Insurance Policy?

A policy with a goal of supplementing retirement income from the cash value account is usually designed with increasing death benefit. This allows the maximum amount of premium to be invested in a cash value account in the early years of the policy. Premiums are usually allocated into three buckets: pure cost of insurance which is to pay death benefit, cash value account, and administration fees. Administration is usually unchanged. With lowest possible death benefit to start with, lowest premium will be allocated to pay for pure cost of insurance, leaving the maximum amount of premium to be allocated to cash value account. This allows the cash value to grow faster and become more substantial.

The other option to design an universal life insurance policy is level death benefit, which means that in the premium-paying years, death benefit is always the same. This design is suitable for people who care for both a decent amount of death benefits for their beneficiaries if they pass away young and supplemental retirement income from the policy.

Withdrawing From and Loans Against the Cash Value Account of Indexed Universal Life Insurance Policy

Mary can make a partial withdrawal on her cash value: this carries a fee of 2% of the amount withdrawn, but not more than $25.00. 

She can also take one of two types of loans:

  • Traditional loan: traditional loans are charged interest at the adjustable loan rate, which is currently 3.40%. 
  • Indexed loans: are charged interest at a rate of 6%. According the illustration of the policy, Mary has a traditional loan option.

When Mary starts to take cash withdrawals at age 60, she won’t have to pay income taxes on the cash distribution. Another plus is that money from your cash value won’t affect your income tax bracket. This is the biggest advantage of an Indexed Universal Life Insurance policy over other retirement savings option and also the biggest tax benefit in the tax code, according to tax expert Ed Slott. Here is his further explanation of this amazing benefit.

See our article “Tax Benefits of Life Insurance: Compare with Other Retirement and Investment Options” for more information on retirement funding.

When combined with Social Security and other retirement accounts, a structured IUL policy is an excellent way to supplement your retirement income. 

Why can’t I just Invest in Mutual Funds or ETF or Index Funds?

Of course, you can. Mary can take that $500 and invest it directly in the market, or in a variety of mutual funds, EFT, or index funds. As we have seen lately, the stock market can fluctuate wildly. Over the long-term it usually recoups any losses, but Mary will have to learn to account for that. 

She will also have to hang onto to her investments for at least a year, or she will incur short-term capital gains taxes, taxed at her ordinary income tax level. If she keeps pouring money into the investment account for 18 years and withdraw afterwards, she will be taxed at long-term capital gains tax rates. And her withdrawal from her investment account will be considered as her income and taxed accordingly. It will also affect her income tax bucket. Learn more about the differences between IUL policy and investment accounts in retirement planning.

Also, it’s difficult to consistently invest in the market. With an IUL policy, Mary will have an incentive to keep investing to avoid her policy lapsed. This might make an IUL policy worth it for Mary. 

Pros and Cons of Indexed Universal Life Insurance


  • May offer better long-term growth than other UL plans
  • Much less expensive than whole life insurance
  • Lower risk than investing in stocks
  • Much safer option in bear market conditions compare to investing in stocks or variable universal life insurance
  • No limit to the amount you can contribute to an IUL policy (as long as it doesn’t turn into an MEC (modified endowment contract)
  • Tax-free cash out from the policy in retirement
  • Tax-free death benefit for beneficiaries


  • In a bull market year, IUL might pay lower returns than other UL policies such as variable universal or investment account if you are good at investing
  • No opportunity to outperform the market
  • No dividends

>>MORE: The Differences between Whole Life and Indexed Universal Life Insurance

Who is Indexed Universal Life Insurance Policy for?

If you’re a savvy investor who had already maxed out your 401(K) and other retirement accounts, an IUL policy can be a great way to supplement your retirement income. You also get the advantage of having a life insurance policy, or death benefit, to pass onto your heirs. This will allow them a tax-free inheritance, thus allowing for a handy estate planning strategy. 

If you need life insurance and would also like tax-advantaged cash value to draw from without the risk of stock market investing, an IUL policy might be perfect for you.

>>MORE: Why is Whole Life Insurance Not Worth It?

Conclusion/Last Thoughts

Many people are concerned about how they will fund retirement. A retirement strategy that invests in multiple accounts and includes life insurance is a sound, multi-faceted plan. An IUL policy offers many tax advantages, with less risk than mutual funds or other investments.

Thang Truong

Thang Truong covers small business insurance and small business success at BravoPolicy. He is a licensed P&C insurance agent. Previously, he held product leadership positions at realtor.com, Capital One, NerdWallet, and Mulberry Technology. He holds a MBA degree from UC Berkeley - Haas School of Business.

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