Variable Universal Life Insurance: An Insurance Alternative With Earning Potential
One of the main reasons people get life insurance is so that they can leave an inheritance for their loved ones. But what if you want to do more with your life insurance policy?
This is where variable universal life insurance (also called a VUL) comes in. With a VUL, your insurance can be used for other things in addition to protecting you and your family.
In this guide, we’ll talk about how you can invest with variable life insurance, as well as what you should consider before signing up for a VUL.
What Is Variable Universal Life Insurance?
Variable universal life insurance is a type of permanent life insurance policy. VUL insurance policies provide lifelong protection in exchange for regular premium payments. This protection is provided in the form of a tax-free death benefit payout to your beneficiaries.
These life insurance policies combine the features of variable life and universal life insurance. Like variable life insurance, VULs have a savings component. This allows you to invest in separate accounts with variable values – typically into stock and bond markets.
Similar to a universal life insurance policy, a VUL grants you flexibility in your premium payments and benefit amount. Your premiums have a minimum and maximum value defined by the Internal Revenue Code. This policy also allows you to adjust the face value/death benefit amount.
Compared to other whole life insurance products, there’s more potential for your cash value to increase with a variable universal life policy. This makes VUL policies a viable option to expand your investment portfolio while also protecting your family. However, keep in mind that your investments’ performance will have a direct impact on your policy’s value.
How VUL Investments Work
VULs differ from other insurance products because of its investing component. In this section, we’ll go over the inner workings of investing with your VUL.
What Funds Your Cash Value
A portion of your premium payments goes into the VUL’s cash value savings component. Whenever you pay your premiums, the money is split into three parts: the cost of insurance, the insurer’s operating costs, and your cash value.
This cash value is separate from your death benefit and is used for your investments. You can receive the cash value from the life insurance company if you decide to surrender your life insurance coverage.
How Your Cash Value Is Invested
In a VUL, your policy’s cash value can be used for investments. Your life insurance company will give you investment options, divided into different sub-accounts. Common options include stocks, bonds, and the money market. Your investment fund is managed by a financial professional, like in mutual funds.
When investing with a variable life insurance policy’s cash value, you should consider both management fees and market risk. Some life insurance policies also have a maximum rate of return, capping your gains even when your investment options perform well. High management fees would further reduce your investment return.
How Variable Universal Life Insurance Can Help You
In addition to investing, variable universal life insurance comes with other features as well. In this section, we’ll explain how VUL can benefit you and your family.
Additional Tax-Deferred Retirement Savings
Retirement accounts have upper limits. For example, 401(k) contributions are limited to $19,500 per year. If you’ve reached that limit and would like to save more for your old age, you can opt for a VUL. The money saved in your policy is protected from income tax obligations and can be used for investments as well, potentially growing your retirement savings further.
Protect Your Inheritance From Tax
Inheritance is tax-free if the total value of the inherited assets is under $11.38 million. If your total exceeds that, the tax-deferred death benefit provided by a VUL can help cover your inheritance tax.
Cash Value Can Be Another Source Of Funds
Like any other cash value life insurance product, you can use your VUL’s cash value for various purposes. One of the most popular uses is as collateral for policy loans. Some life insurance companies also allow you to use your cash value to increase your death benefit.
Benefits Of VUL
Minimum Guaranteed Death Benefits
Even if your policy devalues as a result of your investment portfolio’s performance, your variable life insurance policy comes with a minimum guaranteed death benefit. As long as your premiums are paid, your death benefit value will never fall below this amount.
With a VUL, you can adjust how much you pay on premiums. If you’ve accumulated some cash value on your policy, you can use part of it to pay for your premiums.
Conversely, if you pay more than your normal premium charge, the extra money increases your cash value. In fact, overpaying your insurance payments is a great way to accelerate your cash value growth.
In addition to insurance coverage, owning a VUL policy means you’re investing in stocks, bonds, and the money market with earning potential. The returns on your investment will build up your cash value, thus increasing your policy’s value.
Level Of Control For Cash Value Investments
When investing in a VUL, you put your cash value in underlying investment options provided by your life insurance company. These sub-accounts have varying risk profiles. You can choose whichever investment option fits your long-term investment objectives and risk tolerance.
Disadvantages Of VUL
While all cash-value insurance products charge fees, VUL policies may saddle you with more fees. Most of these fees go towards the management of your investment sub-accounts.
You may also be subject to fees if you withdraw or borrow against your cash value. Surrendering your life insurance coverage usually comes with surrender charges as well, reducing the amount of money you receive.
More Complex Than Most Other Insurance Types
Variable universal life insurance requires more attention compared to other life insurance products due to the relative unpredictability of investments. If you invest your cash value in several different investment accounts, you need to watch your investments closely so that you can make better financial decisions and change accounts if necessary.
Potential For Cash Value Loss
VUL policies allow you to earn more, but you also bear the risk of losing on your investments. If your investment performance drops, your cash value will decrease. If your cash value drops low enough, you may be charged higher premiums to keep your insurance coverage active.
Considerations When Applying For A VUL
In addition to its pros and cons, there are three essential things you need to think about before applying for a VUL. These considerations will help you understand if a VUL is the right choice for you.
Having a VUL policy means that you accept any investment risk, including those that may devalue your policy. If you’re looking for a risk-free option to protect your loved ones, then VUL insurance may not be right for you.
On top of the standard operating fees associated with life insurance policies, VULs also come with additional costs for managing your investments. If you apply for a VUL policy, you have to be able to pay for these costs to keep your policy in effect.
A VUL’s investment component is managed by a financial professional, much like a mutual funds or brokerage account. However, we don’t recommend that you rely completely on your account manager to make the decisions for you.
Market fluctuations and other factors may influence your investments. While you don’t need to be a financial professional, you still need to keep a close eye on your accounts (and the market) and make decisions accordingly. This can be the difference between suffering losses or growing your hard-earned money.
Alternatives To VUL
With its complexity, variable life insurance may not be right for everyone. In this section, we’ll go over alternative life insurance products and investment vehicles.
Whole Life Insurance
Whole life insurance, also called permanent life insurance, provides lifelong coverage in exchange for premiums. Similar to variable universal life policies, permanent life insurance policies also feature a cash value component that builds interest during the insurance life. Compared to a VUL, cash value accumulation on a whole life insurance policy is slower but is also less likely to devalue.
If you’re looking for long-term care and protection without the complexity of VUL, you can opt for a whole life policy.
Final Expense Life Insurance
Final expense life insurance is a form of permanent life insurance that provides whole life coverage with a smaller face amount. The upside is that qualifying for this type of life insurance product is much easier because there’s no medical exam. If you have a hard time qualifying for other types of life insurance due to age or health issues, you should consider final expense life insurance.
Term Life Insurance
If you only need to protect yourself for a limited amount of time, you can consider a term life policy. This type of policy has a limited insurance life – usually 10, 20, or 30 years.
If you die during the covered period, your family will receive a death benefit. Conversely, if you outlive your life insurance term, then you’ll receive nothing. If you want affordable rates and know how long you need to be insured, then term life insurance is the best alternative for you.
As an alternative investment vehicle for your retirement, you can purchase a variable annuity. In this type of investment, the life insurance company agrees to pay you (or your beneficiaries) periodically for the rest of your life, instead of in a lump sum.
Depending on your agreement, the insurer can either start paying immediately or at a later date. To protect your family further, variable annuities also pay out a sum if you pass away before the insurer starts their periodic payments.
Variable universal life insurance is slightly more complex because of its investment component. This policy allows you to take on extra risk and potentially increase your cash value quickly. However, if your investments perform poorly, you may need to put more money into your policy to keep it active.