IUL’s or Indexed Universal Life Insurance: Here is some math (just don’t).
Let me be frank about this. IUL’s are a scam. If an insurance agent or broker suggests this is a good idea, get a different agent.
Indexed Universal Life Insurance (IUL) policies are often marketed as a "safe" way to capture market gains with downside protection. For many, this sounds ideal—especially those looking for both insurance coverage and investment growth. But beneath the surface, IULs come with limitations and fees that reduce returns substantially. In this article, we’ll break down how an IUL performs compared to a straightforward investment in the S&P 500 over 15 years, using real-world scenarios to highlight the impact of fees, missed dividends, and capped returns.
Understanding the Mechanics of IULs: Hidden Costs and Capped Growth
An IUL is a form of life insurance policy that ties its growth to a market index, often the S&P 500. This setup gives the impression of capturing stock market growth without risk, but here are some commonly overlooked issues:
Fee Structure: IULs often have administrative charges, mortality costs, and other policy fees that add up to 2-3% per year. These fees cut into returns, meaning that even if the index performs well, a significant portion of the growth is lost.
Return Caps: IULs cap growth, with caps typically between 6-8% annually. In years when the market performs above this cap, policyholders miss out on potential gains.
Dividends Not Included: In a traditional S&P 500 index fund, investors benefit from both stock price appreciation and dividends (about 1.5-2% annually on average). IULs exclude dividends, reducing the overall return potential.
Case Study 1: Investing $10,000 in an IUL vs. S&P 500 over 15 Years
To illustrate these differences, let’s take a hypothetical scenario. Imagine a $10,000 initial investment, held for 15 years, and compare the growth between a capped IUL and a direct investment in the S&P 500.
Assumptions:
S&P 500 Investment: Average annual return of 10% (including dividends)
IUL: 6% cap, 2.5% annual fees, and no dividends
Results After 15 Years
S&P 500 Investment: Grows to $41,772
IUL Investment: Grows to $23,462
In this example, the straightforward S&P 500 investment nearly doubles the IUL’s performance. Despite the IUL’s “safety,” the combination of fees, capped growth, and missed dividends leads to a significant reduction in returns.
Case Study 2: Examining Fees and Their Compounding Impact Over Time
Consider a second example to highlight the impact of fees over different time horizons. Imagine the same $10,000 investment, but let’s increase the holding period to 30 years and apply the IUL’s typical fee structure of 2.5% annually.
Assumptions:
S&P 500 Investment: Average return of 10%
IUL: 6% cap, 2.5% annual fees
Results After 30 Years:
S&P 500 Investment: Grows to $174,494
IUL Investment: Grows to $43,219
Here, after 30 years, the impact of fees compounds even further, and the IUL investment ends up around 75% less than the S&P 500 investment. Even though the IUL appears to provide safety, the growth potential is severely limited by ongoing costs.
Case Study 3: The Impact of Market Cycles and Downturns
One of the main selling points of IULs is their protection against market downturns. While it's true that IULs can prevent direct losses in a bear market, the math shows that these policies can still underperform over the long term.
Let’s look at a hypothetical scenario where we experience two significant downturns in a 20-year period, such as in 2008 and 2020. Assume that in those years, the S&P 500 saw losses of 37% and 18%, respectively. For simplicity, we’ll assume a $10,000 investment at the start and average annual returns of 10% for the S&P 500 (excluding these down years) and an IUL with a 6% cap.
Results After 20 Years:
S&P 500 with Downturns: Grows to around $57,275, after including the two years of downturns
IUL: Grows to around $32,071 with its 6% cap and annual fees
Even with the two significant downturns, the S&P 500 still outperforms the IUL. The "protection" from losses in an IUL is not enough to offset the long-term impact of caps, fees, and missed dividends.
In Summary: The True Cost of IULs Compared to the S&P 500
These scenarios illustrate how fees, caps, and missed dividends significantly reduce the long-term returns of an IUL. While the idea of a “safe” investment may sound attractive, the limitations and expenses of an IUL mean it often benefits insurance companies more than policyholders.
For veterans and anyone looking to grow wealth effectively, understanding the math behind IULs is essential. Simple, low-cost index funds like the S&P 500 often provide higher returns with far more transparency and fewer fees. In the end, the numbers show that, while IULs might protect against losses, the price for that protection is lower long-term growth—something that investors should weigh carefully when planning their financial future.
