Variable universal life insurance (VUL) is a life insurance type that accrues a cash value. In VUL, the cash value is invested in various separate accounts, akin to mutual funds. The contract owner enjoys complete autonomy in selecting from the available accounts.
The term “variable” pertains to the ability to invest in separate accounts, the values of which fluctuate based on the stock and/or bond markets. Meanwhile, the term “universal” denotes the flexibility the owner possesses in making premium payments.
Premiums for VUL can vary from zero to the maximum defined by the Internal Revenue Code for life insurance. This flexibility stands in contrast to whole life insurance, which requires fixed premium payments and lapses the policy if missed.
What Is Variable Universal Life (VUL) Insurance?
VUL insurance offers lifelong insurance protection with flexible premiums and cash value that can be used while the policyholder is alive.
The cash value can be capitalized or invested in subaccounts that function like mutual funds, and it can produce high returns but may also result in substantial losses due to exposure to market fluctuations.
VUL is similar to variable life insurance, but it varies in that it permits the policyholder to adjust their premium payment amount.
While VUL insurance provides more flexibility and growth potential than other life insurance options, it is essential to estimate the risks carefully before purchasing it.
How Variable Universal Life (VUL) Insurance Works
Variable universal life insurance is a kind of permanent life insurance policy that provides both a death benefit and a savings component known as cash value.
This insurance policy can last you forever, provided you keep paying for the insurance costs. With VUL, you can adjust your premium payments every year, just as with traditional universal life insurance.
It is very important to pay enough every year to cover the ongoing insurance costs of your policy, which the insurer will remove from your premiums. The amount left in your premium payments will go towards your policy’s cash value.
Investment Risk And Cash Value
In a VUL, you get to select how to invest your cash value among a variety of sub-accounts, and your interest and future growth depend on the investment performance.
If your investments do well, your cash value will rise more quickly. The growth of a VUL insurance policy’s cash value is tax-deferred, and policyholders can access their cash value by taking out a withdrawal or borrowing funds.
However, if your investment is poor, your cash value will not rise as quickly, and it is possible to lose money with a VUL.
If you face noteworthy losses, you may have to make larger premium payments to cover the cost of your life insurance and rebuild your cash value. Otherwise, your policy could break, and you would lose insurance protection.
Benefits Of A Variable Universal Life Policy
VUL insurance offers several benefits that you should be aware of, and they are as follows:
Flexibility is the key advantage of a VUL policy. It permits you to adjust the death benefit up and down, subject to new medical underwriting for an increase.
You can also adjust the size or rate of premium payments if your income changes. However, changing your premiums can affect the speed at which you grow cash value and the amount of the death benefit.
You’re Protected For Life
Another benefit of VUL insurance is lifelong coverage, provided that you pay the premiums due. This makes sure you are protected for life.
There Are Tax Advantages
Also, there are tax advantages to VUL insurance. Your recipients won’t have to pay income taxes on the death benefit, and you can enjoy tax-deferred growth on your cash value.
However, there are certain instances where you will face taxes, like withdrawing money from your cash value where a portion of the withdrawal is above the policy basis or taking out a policy loan that you do not pay back, where the portion of the loan from investment gains is taxable.
Disadvantages Of A VUL Policy
It is important to weigh the advantages and disadvantages of any decision. This is particularly true in the case of variable universal life (VUL) insurance.
While there are benefits to this type of permanent life insurance, there are also some disadvantages that you should take into account.
Your Cash Value Can Drop
One major downside is the risk involved with the investment side of a VUL policy. Different from other types of permanent life insurance, the investment side of VUL is much riskier.
Although you can build your cash value when the market performs well, you can also lose money if the market drops.
Another factor to consider is that there is no cap on the cash value of a VUL policy. This means that there is no limit to how high your cash value earnings can be, but there is also no limit to how low they can be. If the cash value drops too low, you will need to make extra premium payments to avoid a policy lapse.
You Might See Better Returns Elsewhere
Besides, VUL insurance can be expensive. It comes with a lot of fees, including the cost of insurance (the actual cost of insuring your life), administrative costs, and other charges.
If your policy has high internal charges, they will eat into the amount that goes to your cash value, eventually reducing your potential investment growth.
Tips For Buying Variable Universal Life Insurance
If you’d like to buy this type of insurance policy, here are a few tips you could use.
Know The Cost Of The Policy
When you’re thinking about getting Variable Universal Life (VUL) insurance, it’s not just the premiums you pay that matter. You should also pay attention to other costs, like the monthly charges for things such as the actual cost of insurance (which covers your life) and policy fees.
If you choose a VUL policy with high fees, it means less of your money from premiums goes into building up cash value. Having less cash value means you won’t have as much to take out or borrow.
So, even if a VUL policy has low premiums, it might not be a good deal if it comes with high internal charges. It’s important to find a balance between premiums and charges to make sure you get the most value from your policy.
Examine The VUL Policy Illustration Before You Buy
Always check the guaranteed parts of your VUL policy, which are displayed in the policy illustration. Don’t decide to get life insurance just because the non-guaranteed parts of the illustration look good. It’s essential to have a realistic view.
A knowledgeable financial advisor can assist you in understanding what could happen in the worst-case scenarios of the policy, especially if your investments don’t perform well. They can help you plan for any potential challenges.
Look At The Insurance Company’s Financial Strength
Financial strength ratings tell you how capable an insurance company is of paying claims in the future. Different agencies, like AM Best, Moody’s, and Standard & Poor’s, provide these ratings.
Checking these ratings helps you make sure the insurance company is strong and reliable for the long term.
Work With A Professional Who Understands VUL
If you’re thinking about getting VUL, it’s crucial to team up with a knowledgeable financial advisor or an experienced life insurance agent who knows about VUL and can guide you through it.
Make sure to grasp the level of involvement you’ll have in managing the investments in the sub-accounts.
In conclusion, if growing your wealth through investing is your primary goal, you might want to consider other options.
While VUL insurance permits you to earn greater returns through market exposure, there are limitations to your investment choices and growth.
You may be better off putting your money in a tax-advantaged retirement savings vehicle, like a 401(k) or IRA, or even a taxable brokerage account.