Variable Universal Life Insurance

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21 Aug, 2024

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Variable universal life insurance is life insurance with flexible premiums and cash values as long as an insurer is alive. It is an agreement between the holder and the insurance company. The primary aim of this insurance is to provide a flexible financial tool that combines life insurance protection with the potential for cash value growth.

VUL policies offer a death benefit like traditional life insurance policies. Still, they also provide a cash value component that can be invested in various sub-accounts, similar to mutual funds. Moreover, these policies are suitable for individuals who are comfortable with investment risk and want the potential for cash value growth while maintaining a life insurance component.

Variable Universal Life Insurance (VUL) Meaning

Variable Universal Life (VUL) is a policy that combines life insurance with investment options and offers flexibility in premium payments and investment allocations.
These premiums are split between investment subaccounts and the cost of insurance coverage. Flexible premium payments need to cover policy fees and expenses.
The policy's cash value growth is tied to the performance of the underlying investments. It is vulnerable as it is subject to market risks, and underperforming investments can reduce the policy's value.
Moreover, it provides the potential for investment growth but carries investment risks and requires ongoing premium management.

How Does Variable Universal Life Insurance Work?

Variable Universal Life insurance is a life insurance policy that offers life insurance benefits as an investment. Hence, one of the distinguishing features of VUL is the ability to access the cash value while alive. Therefore, this feature can be valuable for various financial needs, such as supplementing retirement income, paying for education, or covering unexpected expenses.

Here's how VUL works:

The policyholder can select the investments for the allotted funds, such as bonds, stocks, or money market funds. There may also be an option to allocate premiums to a fixed account with a guaranteed minimum interest rate.
Furthermore, the account value fluctuates based on premium payments, fees, expenses, and the performance of chosen investments. The policy's cash value increases depending on how well these assets perform. It shall be noted that the cash value is vulnerable as it is subject to market risks, and underperforming investments can reduce the policy's value.
The life insurance offers a death benefit, which can be higher than the premiums paid. It allows the holder to pay a specified amount of premiums or vary them based on policy requirements. Moreover, the death benefit is typically income tax-free and can be used to provide financial security.

Thus, flexible premium variable universal life policies come with fees and expenses, including insurance charges, administrative fees, and investment management fees. These costs can impact the overall performance of the policy. Higher premium payments can reduce specific fees and costs as they lower the net amount of risk, which is the difference between the policy's face amount and cash value.

Additionally, a variable universal life insurance calculator helps understand how premiums, investment choices, and other factors may impact the performance of a VUL policy.

Examples

Check out these examples to get a better idea:

Example #1

Let’s understand the concept with the help of an example.

Imagine Kate, a 35-year-old professional who wants to secure her family's financial future while building an investment portfolio. She purchased a VUL policy with a $500,000 death benefit. Moreover, she enjoys VUL's flexibility, allowing her to adjust her premium payments based on her income fluctuations. She allocates a portion of her premium payments into various sub-accounts within the policy, including a mix of stocks and bonds tailored to her risk tolerance and investment goals. Over the years, the cash value in her VUL policy has grown, benefiting from the performance of her chosen investments.

She also appreciates accessing this cash value when needed to supplement her retirement income and cover her children's college expenses. The tax-deferred growth of her VUL policy offers advantages for long-term financial planning, and the death benefit provides peace of mind, ensuring her family's financial security in case of an unfortunate event. Thus, she regularly reviews her policy with a financial advisor to adjust as her financial goals evolve.

Example #2

Let's say David is a 45-year-old entrepreneur with a growing family and a strong desire to protect their financial future and invest wisely. David purchased a variable universal life insurance death benefit policy with a $1,000,000 death benefit. Given his variable income as a business owner, he appreciates the flexibility VUL offers in adjusting his premium payments. David allocates a portion of his premiums into a mix of diverse sub-accounts within the policy, including equity and bond funds.

Over the years, his cash value steadily grows, benefiting from market upswings, although he understands it can also fluctuate. Hence, this cash value proves invaluable when David wants to fund his children's college tuition and, later in life, supplement his retirement income. The tax-deferred growth of the policy's cash value aligns with his long-term financial goals, while the death benefit protects his family's financial security.

Tax Benefits

Variable Universal Life (VUL) insurance policies offer several tax benefits that can make them attractive for specific individuals. Here are some of the key tax advantages associated with VUL:

The beneficiaries won't be required to pay income taxes on the death benefit. Hence, variable universal life insurance death benefit is considered one of the significant advantages of having life insurance. It is typically exempt from federal income tax and, in some cases, may be exempt from federal estate tax.
Gains are not taxed at the lower capital gains rates but at the usual income tax rates.
Federal income taxes are typically not due on loans from the policy, but they might be if the insurance terminates with a still unpaid loan.
Moreover, the insured can access the cash value in their VUL policy through withdrawals during their lifetime, and these withdrawals are generally income-tax-free. Hence, this allows them to tap into their policy's cash value to cover various financial needs without incurring immediate tax liabilities.

Pros And Cons

Here are the main pros and cons of variable universal life insurance:

Pros

It offers flexible premium payment options. Variable universal life insurance death benefit is hence one of its attractive points.
This insurance policy has the potential for higher returns than other types of permanent life insurance.
Moreover, it allows allocation based on individual risk tolerance.
VUL allows the policyholder to borrow money against the policy's cash value.
They allow the insured to adjust the amount and frequency of premium payments within certain limits. This flexibility is beneficial if the financial situation changes.
Thus, it offers tax-deferred growth on the cash value, meaning one does not have to pay taxes on the earnings within the policy until the policy is withdrawn.

Cons

Cash value may decrease due to poor investment performance.
Higher fees compared to universal life insurance.
The complex nature of the policy requires close monitoring throughout its duration.
Overfunding the policy can have tax consequences and may not be suitable for individuals who have maximized other tax-advantaged retirement accounts.
VUL is a complex financial product, and understanding how it works and the associated risks can be challenging.

Variable Universal Life Insurance vs Indexed Universal Life vs Variable Life Insurance

The differences between the three are given as follows:

Key Points	Variable Universal Life Insurance	Indexed Universal Life	Variable Life Insurance
Concept	Permanent life insurance with a death benefit and an investment component is known as variable universal life insurance or VUL.	Indexed universal life insurance (IUL) is a type of life insurance that provides both a death payment and a chance for a cash value increase.	Variable life insurance is a type of life insurance that offers both a death payout and an investment component.
Payments	The choice to divide their premium payments among other investment alternatives, such as stocks, bonds, or mutual funds, is up to the policyholder. It is also known as flexible premium variable universal life insurance due to this factor.	Here, the policy's cash value changes according to how well the selected investments perform.	Flexible premium payments are similar to VULs.
Cash value	Here, the policy's cash value change according to how well the selected investments perform.	This insurance cash value growth depends on how well certain stock market indices, such as the S&P 500 index, perform. IUL plans offer the possibility for growth based on the success of the index while also providing downside security against market losses.	Moreover, the policy's cash value varies according to how well the selected assets perform, which offers the possibility of more significant returns but also exposes the policy to investment risks.

Frequently Asked Questions (FAQs)

1. Is variable universal life insurance worth it?

Depending on personal financial objectives, risk tolerance, and environmental factors, variable universal life insurance may or may not be worthwhile. Although it comes with risks and higher fees, it also can provide benefits, including flexibility and investment growth. Hence, it can be opted for after careful planning.

2. What is group variable universal life insurance?

Group VUL could refer to a type of life insurance provided to a group of people, often through a company or organization. The advantages of group coverage are combined with the benefits of variable universal life insurance, which is typically low-cost.

3. How to cancel variable universal life insurance?

Cancelling these insurances involves contacting the provider or the respective broker. The cancellation procedure may change according to the insurer and the insurance terms. Before withdrawing, it's crucial to consider any prospective surrender fees or costs.

4. Is variable universal life insurance a security?

VUL is not regarded as a security in and of itself. The policy's underlying investment possibilities, such as mutual funds, could be subject to securities regulation.