What is Variable Universal Life Insurance?

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    Your financial advisor — or maybe a neighbor who sells insurance — may have pitched you on a variable universal life insurance policy. You have questions, and rightfully so. Variable universal life, also known as VUL, is a complex product that isn’t right for everyone. Here’s a closer look at VUL and the role it could play in your finances.


    Variable universal life insurance definition 

    What is variable universal life insurance? VUL is a type of cash-value life insurance that has a flexible premium, fixed death benefit, and investment options that function like mutual funds. Let’s break down what those features mean: 

    • Cash-value life insurance: Cash-value life insurance offers a built-in savings account as well as a death benefit. The savings portion of the policy is invested and grows over time. Depending on the type of policy, you can access your cash value by withdrawing funds, borrowing funds, or surrendering the policy. You could even sell the policy to a third party in a life settlement.
    • Flexible premium: Life insurance premiums can be fixed or flexible. If your policy has a fixed premium, you must pay that amount or risk letting your policy lapse. When the premium is flexible, you can pay more than the recommended amount or less. You’d pay more to expedite the growth of your cash value. You might pay less to manage through a temporary budget constraint. When you pay a lower premium, the insurer uses your cash value to cover the policy’s minimum costs. If your cash value is insufficient, the insurer will ask you to pay in more to keep your policy in force.
    • Fixed death benefit: Some policy types adjust the amount of the death benefit according to how the savings portion of the policy grows over time. Variable universal life insurance does not work that way; the death benefit is guaranteed regardless of the performance of the policy’s investments. Note that the death benefit would change in a VUL policy if you borrowed against your cash value.
    • Investment options: You invest your VUL cash value in funds called “sub-accounts.” Each sub-account has a specific investment strategy, such as blue-chip equities or international bonds. When you initiate your VUL life insurance, you select a combination of sub-accounts that matches your risk tolerance and overall financial strategy. Your premiums, less any administrative and insurance fees, are then invested in your chosen sub-accounts.

      The performance of those sub-accounts dictates how your cash value grows over time. If the sub-accounts perform well, your cash value balance grows faster. If the sub-accounts perform badly, you could see your cash value decrease.  


    How VUL differs from universal, variable life 

    Variable universal life is easy to confuse with universal life and variable life — because it has a similar name, but also because it blends key features from these other policy types. The table below shows how VUL compares to universal life and variable life, with additional explanation provided below.  

    Policy type Premium  Death Benefit   Investments
    Variable universal life  Flexible  Fixed Policyholder selects sub-account investments, which perform according to market conditions.
    Universal life  Flexible Fixed  Any premiums paid that exceed policy costs are funneled into a savings account that grows according to market interest rates.
    Variable life  Fixed  Fluctuates  Policyholder selects sub-account investments, which perform according to market conditions. Performance does affect the policy’s death benefit.  


    Variable universal life vs. universal life 

    Universal life policies do not use the VUL sub-account system for investing. Instead, your universal life investment portion grows according to market rates or a minimum rate that’s defined in the policy. A universal life policy has lower growth potential vs. a VUL, but also a lower risk of loss.  

    Both variable universal life and universal life policies have a flexible premium, which is an advantage over variable life policies. 

    Variable universal life vs. variable life 

    Both variable life and variable universal life have sub-account options for investing. What differentiates variable universal life from variable life is how investment performance affects the death benefit. In a VUL, your death benefit remains fixed as long as you pay minimum premiums and you don’t borrow against your cash value. The rise and fall of your sub-accounts will never change your death benefit.  

    That’s not the case with variable life. This is a life policy with a death benefit that can fluctuate according to investment performance. Most variable life policies will have a minimum death benefit, however. If the investment portion of the policy devalues enough, the death benefit can drop down to the minimum, but not below it.


    Pros of cash-value life insurance: financial flexibility 

    All cash-value life insurance policies share some advantages and disadvantages. It’s helpful to understand those pros and cons so you can better assess VUL relative to other cash-value insurance options. Someone might tell you, for example, that VUL offers tax-deferred investment growth. That is true, but that benefit isn’t unique to VUL. All cash-value policies provide tax-deferred investment growth — it’s one of the main reasons people buy this type of life insurance.

    Another appealing aspect of cash-value life insurance is the ability to access invested funds without tax consequences. Your options will depend on the policy rules, but you can either borrow against your cash value or withdraw the money directly. Interest rates on cash-value loans are competitive and there’s typically no repayment schedule. As long as you don’t borrow or withdraw more than you’ve paid in premiums, you won’t pay taxes on the transaction. 

    You also have the option to cash out or sell your policy, albeit with tax consequences. To cash out, you’d tell your insurer you’re surrendering the policy. The insurer would pay out your cash value less any surrender fees. Selling your policy in a life settlement should raise more cash, since a policy’s market value is usually higher than its accumulated cash value. Either strategy would eliminate your policy premiums going forward.


    Cons of cash-value life insurance: cost 

    While cash-value life insurance does offer some financial flexibility as your cash value grows, it is expensive. The fees embedded in your policy reduce your investment returns. For that reason, critics argue that cash-value life insurance isn’t competitive as an investment vehicle — since you could avoid those fees by putting your money directly in the stock market. 


    Advantages of VUL 

    VUL shares in the pros and cons of cash-value life insurance described above. But VUL also has its own differentiators relative to other types of cash-value policies, including these four advantages.

    1. More control over your investments 

    VUL’s sub-account system for investing cash value gives you more control over risk exposure and asset allocation. You’d choose your sub-accounts in the same way you’d choose mutual funds within an investment account. If you want to position your policy investments conservatively, for example, you might rely on fixed-income sub-accounts. If you want the highest potential for capital growth, you might select sub-accounts that invest in small- and mid-cap equities. 

    2. Potential for higher returns 

    Because sub-accounts are financial market funds, you do have the potential to earn more in VUL vs. other forms of cash-value life insurance.

    3. Fixed death benefit 

    As noted, the underlying performance of your VUL investments does not change your death benefit. In a variable life policy, your death benefit would fluctuate with investment performance. 

    4. Flexibility on premium payments 

    You do have the flexibility to increase or decrease your VUL premium payments. 


    Disadvantages of VUL 

    Now, for the disadvantages. Relative to other types of cash-value life insurance, VUL can be risky, expensive and complex. Keep these five disadvantages in mind as you research your insurance options.

    1. Higher risk of loss 

    You can earn more in a VUL, but you can also lose more. Poor performance of your sub-accounts will be reflected in your cash value. If the sub-accounts devalue enough, you may have to put more cash in to keep your policy from lapsing. 

    2. Higher fees 

    All cash-value policies have fees built into the premiums and VUL Is no exception. However, a VUL policyholder also absorbs fees that are embedded in the sub-accounts, which range from .5% to 2%. These fees are the sub-account equivalent to a mutual fund’s expense ratio, and they do lower your investment returns.

    3. High surrender charges 

    Surrender charges on VUL policies can be in force for up to 15 years and can be very high in the early years of the policy. Note that you only pay surrender charges if you cancel your policy.

    4. Premiums may rise 

    If your sub-accounts perform badly, your insurer may increase your premiums to ensure your policy is properly funded.

    5. Complexity 

    VUL policies have many moving parts, including sub-accounts that have to be managed over time. Policyowners who misunderstand the nuances of VUL are more likely to experience poor investment performance or see results that don’t match their expectations. 


    Is variable universal life right for you?

    Because of the fees and complexity, VUL should not be your first or only vehicle for retirement savings. Even so, VUL may have a role to play in your finances. Often, this type of policy is most appropriate for high net worth individuals who’ve maxed out other tax-advantaged accounts, including 401(k)s and IRAs. The takeaway? Before initiating a VUL policy, make sure you understand where it fits within your overall financial plan and tailor your expectations accordingly. 


    Selling your variable universal life policy 

    It can take decades to build up a six-figure cash value in your variable universal life policy. In that time, your financial situation and retirement plan could change — to the point that your life insurance no longer makes sense. You may not want to keep paying the premiums, for example, or you might need to raise cash to cover healthcare and other expenses. 

    In that scenario, you can liquidate your variable universal life insurance by way of a life settlement. Selling your policy to a third-party eliminates your insurance premiums and generates a lump sum of cash to you from the buyer. You can then use that cash however you want. You might pay down debt, pad your cash savings, or earmark the funds for medical costs. To learn more about life settlements, contact Harbor Life Settlements today for a free, no-obligation estimate of your policy’s market value. 

    Find out how much your policy is worth.

    Catherine Brock

    Catherine Brock

    Catherine Brock is a personal finance writer who's been featured in The Motley Fool, Refinery29, Wellness.com and has made appearances on ABC7 Chicago, FOX2News St. Louis, KCAL9 Los Angeles, Fox19 Cincinnati, WGN TV Chicago and WCPO TV Cincinnati. When she's not writing, she can be found riding a horse in the country or shopping online for clothes.

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