How to Properly Structure an IUL

Indexed Universal Life (IUL) insurance is one of the most powerful financial tools available when used properly. While many individuals buy IULs with the intention of gaining lifelong protection and accumulating tax-advantaged wealth, few understand the importance of proper structure. A poorly designed IUL can be costly, underperforming, and potentially lapse early. On the other hand, a well-structured IUL can be a tax-efficient powerhouse, providing death benefit protection, flexible cash value growth, and even supplemental retirement income.

In this guide, we break down how to properly structure an IUL policy so it maximizes benefits, minimizes costs, and aligns with your financial goals. Whether you’re a financial professional, an investor, or simply curious about building wealth with life insurance, this guide will give you the comprehensive insights needed to make informed decisions.

Summary

To properly structure an IUL, you must first define your goals—whether it’s maximizing cash value, securing lifetime death benefit, or using it as tax-free retirement income. Once your goal is clear, you can design the policy with minimal cost and maximum efficiency.
Key components include overfunding the policy, selecting the correct death benefit option, staying under Modified Endowment Contract (MEC) limits, and choosing the right indexing strategy for your risk tolerance. Monitoring the policy annually ensures it continues to meet your objectives and remains compliant with IRS regulations.

What is an IUL and Why Structure Matters

An Indexed Universal Life (IUL) insurance policy is a type of permanent life insurance that offers:

• A death benefit to protect loved ones
• Cash value growth tied to a stock market index (e.g., S&P 500), without direct market investment
• Tax-advantaged accumulation and withdrawals

However, unlike term insurance or even traditional whole life, the structure of an IUL heavily impacts its performance. The structure determines:

• How fast your cash value grows
• How much premium goes to costs versus investments
• Whether or not your policy becomes a Modified Endowment Contract (MEC), losing tax advantages
• How sustainable the policy is long-term

In short: the way your IUL is built will either make or break its financial benefits.

Goal Setting: What Do You Want From Your IUL?

Proper structuring starts with goal clarity. Ask yourself:

• Do I want to maximize cash value and build a tax-free income stream?
• Do I need permanent death benefit protection for estate planning or legacy?
• Is this part of a retirement strategy?
• Will I want to borrow against the policy in the future?
• Do I want a low-risk, moderate return investment alternative?

Depending on your goals, the structure will differ. For instance:

• If cash value is your focus: You’ll want to overfund the policy, keep insurance costs minimal, and opt for minimum death benefit structure (Option B initially).
• If you need maximum death benefit: Your structure will allow less room for cash growth.

Set SMART goals:

• Specific: “I want $100,000 in tax-free cash value by age 65.”
• Measurable: “I can contribute $12,000 annually for 20 years.”
• Attainable: Ensure contributions are sustainable.
• Relevant: Align with financial and retirement plans.
• Time-bound: Define when you’ll access funds or benefits.

Overfunding the Policy: How Much Is Enough?

Overfunding means putting more money into the IUL than the cost of insurance requires—up to the IRS limits—so that more goes into your cash value account.

Why overfund?

• Accelerates cash value growth
• Reduces cost of insurance per dollar saved
• Helps prevent early policy lapses

How to do it:

1. Choose the minimum death benefit allowed by law for the premium you want to pay.
2. Work with an advisor to identify the MEC limit.
3. Make consistent premium payments at or near the maximum allowable limit.
4. Fund it early. The earlier you overfund, the more compounding works in your favor.

Realistic Example:

Let’s say you can afford $20,000/year in premium.

• Poorly structured: Base death benefit too high → most of that $20K goes toward cost of insurance → small cash value
• Properly structured: Death benefit set at IRS minimum → $17,000+ goes toward cash value → compounding growth

Choosing the Right Indexing Strategy

An IUL is not invested in the market directly. Instead, the policy earns interest based on the performance of a market index, with cap rates, participation rates, and floors.

Common Indexing Options:

• S&P 500
• Russell 2000
• NASDAQ 100
• Multi-index blends
• Volatility-controlled indices

Key Terms:

• Cap Rate:Max interest you can earn (e.g., 10%)
• Floor: Minimum interest credited even if index performs poorly (typically 0% or 1%)
• Participation Rate: % of index gain credited (e.g., 80%)

Which to Choose?

• Conservative investor: Favor lower caps but stable floors and volatility-managed indices
• Growth-focused: Seek high caps and higher participation rates
• Balanced: Multi-index strategies to spread risk

Many IULs now offer uncapped strategies tied to volatility indices. These may offer lower upside but steadier returns.

Tip:

Use historical backtesting provided by carriers to estimate possible long-term returns, but always remain conservative in projections (e.g., 5-6% average return assumptions).

Minimizing Insurance Costs: Death Benefit Options

Your IUL death benefit structure significantly affects the cost and cash value performance.

There are two main death benefit options:

• Option A (Level Death Benefit):Death benefit remains level. As cash value increases, the insurer decreases the pure insurance amount.
• Option B (Increasing Death Benefit):Death benefit = face amount + cash value. Insurance charges stay higher longer.

Best for Early Growth?

• Option B is usually better in early years as it allows higher premium contributions (higher guideline limits).
• After sufficient growth, you can switch to Option A to reduce cost and lock in cash value.

Target Strategy:

• Start with Option B for the first 10–15 years to grow cash value faster
• Later switch to Option A to preserve gains and reduce cost

Policy Design: MEC Limits, 7-Pay Test & IRS Rules

MEC (Modified Endowment Contract) status is the number 1 tax trap in IULs.

What is a MEC?

If you fund your policy too aggressively, it becomes a MEC, and:

• Loans and withdrawals are taxed like income (LIFO rule)
• No tax-free access to cash value
• 10% IRS penalty if under age 59½

IRS Tests:

• 7-Pay Test: Determines if premiums in the first 7 years exceed allowable levels
• Guideline Premium Test (GPT) and Cash Value Accumulation Test (CVAT): Used to establish how much premium is allowed for a given death benefit

Avoiding MEC:

• Work with an advisor who calculates your policy’s maximum non-MEC funding limit
• Never exceed this unless you intentionally want a MEC (rare)

Always review your policy’s annual statements to ensure it remains compliant.

The Role of Riders and Enhancements

Policy riders are add-ons that enhance flexibility or benefits.

Popular Riders:

• Overloan Protection: Prevents lapse if loans exceed cash value late in life
• Chronic Illness or LTC Rider:Access part of the death benefit early if you’re chronically ill
• Guaranteed Insurability Rider: Buy more insurance in future without medical exam
• Term Riders:Allow more funding room without raising base policy cost

Pro Tip:

Term riders are especially useful in maximum overfunding strategies. They raise the death benefit temporarily to avoid MEC status, letting you stuff more money into cash value.

However, unnecessary riders increase costs. Only add those that:

• Support your financial goals
• Provide essential protection

How to Monitor and Adjust Your IUL Over Time

An IUL is not a “set-it-and-forget-it” product.You need to monitor the policy and adjust accordingly based on evolving needs and circumstances.

Annual Review Checklist:

• Is your policy performing in line with projections?
• Are cap rates, floors, or participation rates changing?
• Are you still within non-MEC limits?
• Has your indexing strategy changed?
• Are loans properly structured to avoid interest buildup?
• Should you switch death benefit options?

Adjustments May Include:

• Reducing/increasing premium contributions
• Switching indexing allocations
• Changing death benefit options
• Taking loans or withdrawals
• Adding/removing riders

Work with a professional annually to run in-force illustrations and stress test the policy under conservative assumptions (e.g., 4% average returns).

Common Mistakes and How to Avoid Them

Mistake #1: Underfunding

• A minimally funded IUL builds slow or no cash value.

Mistake #2: Ignoring MEC status

• Funding too fast can trigger unwanted taxes.

Mistake #3: Choosing wrong death benefit option

• Leads to inefficient use of premiums.

Mistake #4: Ignoring performance

• Failing to monitor cap rates or floor changes can hurt performance.

Mistake #5: Taking loans incorrectly

• Improper loan strategies can cause lapse or taxation.

You can avoid these costly mistakes by working with a knowledgeable advisor, running updated projections, and having annual reviews. You can book a free strategy session with us at Seventi102 Life. We will be glad to be of assistance and help you navigate the intricacies of your policy to tailor it to your specific needs and avoid mistakes that might make the venture unprofitable.

Conclusion

Structuring an Indexed Universal Life insurance policy properly requires thoughtful planning, disciplined funding, and active monitoring. It’s not just about buying a policy—it’s about building a tax-advantaged wealth engine that supports your retirement, protects your loved ones, and gives you financial flexibility.

When done right, an IUL can outperform other financial tools in terms of flexibility, tax-efficiency, and long-term potential. But the key lies in the structure.

Define your goals. Overfund smartly. Choose your strategy. Monitor and adjust regularly.

Indexed Universal Life Insurance(IUL) policies have a lot of features that can potentially provide a safety net for you and for your loved ones. You should check out this video on how to safeguard your future and that of your loved ones against unforseen circumstances like job loss or illnesses.

FAQs

Question 1: Can I change the structure of my IUL after buying it?

Answer: Yes. Most carriers allow changes in death benefit options, indexing strategies, and even premium payments. However, some structural elements are locked after issue, so plan carefully.

Question 2: How much can I contribute without triggering a MEC?

Answer: Your IUL will have a maximum annual premium limit based on your age, death benefit, and IRS tests. Your advisor or the insurer can provide exact numbers for your policy.

Question 3: Is an IUL better than a Roth IRA for retirement income?

Answer: It depends. IULs offer tax-free income, no contribution limits, and protection, but they come with insurance costs. Roth IRAs are simpler but have contribution and income limits. Many people use both.

Question 4: What happens if I stop paying premiums?

Answer: IULs have flexible premiums. If you stop paying, the policy can stay in force as long as cash value covers costs. However, if the policy depletes, it can lapse. Regular reviews prevent this.

Question 5: Can I lose money in an IUL?

Answer: Not in the same way as the stock market. Most IULs have a 0% floor, meaning your cash value won’t drop due to index losses. However, fees and loans can reduce cash value if unmanaged.

We hope you gained much from this article. Our previous article was on asset protection with IUL. You can check it out as it contains a lot of valuable information.