Reconstructing the evolutionary history of protein sequences will provide a better understanding of divergence mechanisms of protein superfamilies and their functions. Long-term protein evolution often includes dynamic changes such as insertion, deletion, and domain shuffling. Such dynamic changes make reconstructing protein sequence evolution difficult and affect the accuracy of molecular evolutionary methods, such as multiple alignments and phylogenetic methods. Unfortunately, currently available simulation methods are not sufficiently flexible and do not allow biologically realistic dynamic protein sequence evolution. We introduce a new method, indel-Seq-Gen (iSG), that can simulate realistic evolutionary processes of protein sequences with insertions and deletions (indels). Unlike other simulation methods, iSG allows the user to simulate multiple subsequences according to different evolutionary parameters, which is necessary for generating realistic protein families with multiple domains. iSG tracks all evolutionary events including indels and outputs the "true" multiple alignment of the simulated sequences. iSG can also generate a larger sequence space by allowing the use of multiple related root sequences. With all these functions, iSG can be used to test the accuracy of, for example, multiple alignment methods, phylogenetic methods, evolutionary hypotheses, ancestral protein reconstruction methods, and protein family classification methods. We empirically evaluated the performance of iSG against currently available methods by simulating the evolution of the G protein-coupled receptor and lipocalin protein families. We examined their true multiple alignments, reconstruction of the transmembrane regions and beta-strands, and the results of similarity search against a protein database using the simulated sequences. We also presented an example of using iSG for examining how phylogenetic reconstruction is affected by high indel rates.