I came across a universal life policy that a man had paid into for five years. He'd put in about $33,000. He had no cash value he could reach. He couldn't take a policy loan, and he couldn't do a 1035 exchange, which means moving a policy's value tax-free into a new one, because there was nothing to move. That's a hard thing to learn after five years.
The numbers were rough. Over those five years, the policy took more than $14,000 in administrative charges, and that didn't count the cost of insurance, which is the monthly charge for the death benefit. This year alone it carried a surrender charge of $19,000. A surrender charge is an amount the company holds back from your cash value if you cancel early. It was cancelling out the roughly $11,000 of growth the policy would otherwise have shown. I'd guess the agent's commission on a policy like that ran about $7,000.
I redesigned it using the same money and the man's age five years later. The new design projected about $5,000 of cash value in the first year. Its surrender charge started near $2,000 and shrank each year. After five years and $35,000 paid in, he could have taken out more than $35,000 even after the surrender charge. A projection isn't a promise, and the real numbers would depend on how the index and the company's charges played out. But the same dollars looked completely different.
Two things made the difference. The first was a lower commission. The commission comes from the base death benefit, so I keep that small and add the rest of the coverage as supplemental term insurance, which pays the agent far less. The second was lower charges, because a smaller base amount means smaller charges against your money early on. Everything you put in above the cost of insurance has a chance to grow, so shrinking that cost helps every later year too.
I thought about this case when I answered a viewer's question about funding a child's IUL. A young policy owner has a very low cost of insurance, so a small monthly amount can go a long way. I fund each of my kids' policies at $3,000 a year, which is the most the design allows. For a 14 or 15 year old putting in $100 a month until 65, I've seen illustrations projecting a retirement income of $60,000 to $80,000 a year. That's a projection, not a guarantee, and a policy loan reduces the cash value and death benefit while it's outstanding.
Most policies look fine next to a savings account if you ignore them for 20 years. Life doesn't wait that long, and people need the money sooner. Whole life can work for a child too, but its cost of insurance is higher, so the cash grows more slowly over 60 years.
Before you sign anything, ask for the cash value and the surrender charge at the end of year one and year five, and ask what the first-year commission is.