I'm looking at a universal life insurance policy that guarantees a return of 3% to 11% and is tax deferred. Is it too good to be true?

As the old saying goes: Anything that seems too good to be true probably is. And that's certainly the case when you're talking about a complicated life insurance policy. In an effort to simplify, it sounds like your agent may have highlighted some of the positive aspects of this policy, while perhaps glossing over the negative ones. You can click here for a review of the specific policy you mention, but first we'd like to go over why we aren't big fans of universal life insurance in general.

As you may already know, a universal life policy is similar to a whole life policy in that it is permanent life insurance that can stay in force until you pass away. It also combines a death benefit (i.e., the amount that's paid out when you die) with a tax-deferred investment or savings component. These policies build a cash-value that you can eventually borrow against. For example, many people will use a universal life policy to help fund their retirement, although that's not something that we'd recommend. (We'll explain why below.)

One so-called advantage of a universal product compared with a whole life policy is that the premium payments are somewhat flexible. As long as you pay enough to maintain the mortality charge (the amount you must pay to cover your death benefit, without any additional return on your investment), you can skip paying some premiums when money is tight. And if you contribute enough during the policy's early years, it can throw off enough income to pay your premium later on. Unfortunately, many agents neglect to mention that if you skimp on premiums during the first few years, you just might be saddled with higher premiums later on, when you expected to be paying little or nothing.

That's not the only potential problem with this type of insurance. A bigger concern is that the promised investment returns often aren't up to snuff. In general, a universal policy that's purportedly tied to an equities index (as is the case with the policy you mention) typically isn't invested purely in that index. In fact, most of your premium dollars are invested in a fixed-income portfolio — at least during the early years. This is how the company can guarantee you a minimum return. You can then opt to invest the rest in a basket of stocks that mimic, say, the S&P 500. This offers you some upside potential should the market outperform your bonds, but it doesn't give you the same return as the equities index itself. Your cash value then grows at a rate of the blended average of your investments, minus all the fees.

And those fees will add up. You'll have to pay an administrative fee, an investment-management fee and expenses that go toward the actual death benefit. Unfortunately, we can't tell you exactly how high these fees will be. The insurance company you asked about wouldn't even estimate it for us, since it depends on so many factors, including your age, smoking status and the face value of the death benefit. But between the fees and the conservative investments, you'll need to hold onto this policy for at least 20 years for it to yield any reasonable return, warns James Hunt, an actuary for the Consumer Federation of America, who has analyzed thousands of policies. Even so, it's the confusing nature of these policies that bothers Hunt most.

If you're still interested, be sure to ask your agent for a personalized illustration of the product that will calculate your annual returns for you, says Michael Boone, a certified financial planner based in Bellevue, Wash. This way, you'll be able to see on paper just how much your policy will yield after all the fees. Just as important, inquire what the penalty is should you decide to surrender your policy. Often, you could lose an entire year's worth of premiums if you discontinue your policy. If after gathering all of this information you're still confused, you could have the Consumer Federation's Hunt analyze your policy for a fee of $50. You can seek out his services by clicking on the Consumer Federation's Web site.

Finally, we noticed that you didn't mention the face value of the death benefit in your question. This concerns us. Are you in the market for life insurance? Or were you simply seduced by the idea of an investment vehicle with a guaranteed return? If you fall into the latter category, don't even think about universal life. Even the folks at AmerUs admit it's too expensive to consider as an investment vehicle only.

If you're merely looking for a safe, conservative investment, you're better off purchasing a bond fund, says certified financial planner Boone. And if you're looking for tax deferral, you can either max out a retirement plan at work, or open an IRA. In rare cases, even a variable annuity could make sense. Of course, your best plan of attack is to hold a diversified portfolio of stocks and bonds that can weather any market.

Generally speaking, we think most people looking for life insurance are better off buying term life insurance. For a considerably lower premium you receive a death benefit for a limited number of years. You can then put the amount you're saving in premiums into a no-load mutual fund. While the market may look miserable now, over the next 20 years you're sure to do better with a diversified portfolio in stocks and bonds than a universal life insurance policy.