Variable Universal Life (VUL) Insurance: A Complete Guide

As a form of permanent life insurance, variable universal life (VUL) offers two things. First, it pays a death benefit to the policyholder’s beneficiaries. Second, it offers “living benefits,” in the form of cash value that the policyholder can access while still living. This growth of a VUL policy’s cash value is based on the performance of investment subaccounts chosen by the policyholder.

VUL offers no guarantees. If an investment portfolio provides strong returns, the policy’s cash value grows. If the investment portfolio tanks, however, then the cash value suffers. The policy may even risk cancellation (including loss of the policy’s death benefit) if the cash value drops far enough.

Let’s take a deeper look at VUL, understand how it works and its pros and cons—and help you decide if it’s the right type of policy for you.

Note: In this article, we’ll discuss some of the tax implications of life insurance. This information is provided for informational purposes only. Consult with a certified tax advisor to better understand your own tax needs.

How does variable universal life insurance work?

When you purchase a VUL policy (or any type of life insurance), you choose a death benefit and assign beneficiaries. Those beneficiaries receive the death benefit if you should pass away. As permanent insurance, a VUL policy is designed to remain in effect until the end of your life, provided you pay sufficient premiums to cover the policy’s insurance costs.

You can adjust the death benefit of a VUL policy as your needs evolve: The life insurance needs of an empty-nest couple who own their home outright, for instance, are typically much different than the needs of young parents with a mortgage and children to raise. Lowering the death benefit also decreases the cost of the policy. This flexibility sets VUL apart from other types of life insurance, such as term and whole life. Note that increasing the death benefit may require additional underwriting, whereas decreasing it does not.

A VUL is also a form of cash value life insurance. This means the policy has a savings and investment feature that can grow over time. The cash value is funded partly by your premium payments and partly by the performance of investment subaccounts. These are investments you choose when you buy the policy and can modify over time as needed. They might include individual stocks, bonds, exchange-traded funds (ETFs), and mutual funds. All are subject to market risks but can be diversified to help mitigate that risk.

Once the cash value reaches a certain level specified by the insurer, you can access it through a withdrawal or loan against the policy. The cash value’s growth is tax-deferred, though accessing it may have tax implications.

If your investments perform well, the cash value will grow quickly. Ideally, the cash value growth can cover some or all of the cost of the policy’s premium and fees. If the investments perform poorly, however, you’ll likely need to make significant premium payments to keep the policy in force. For this reason, it’s crucial that the investment portfolio be managed actively.

Who is variable universal life insurance (VUL) for?

In the world of life insurance, variable universal life (VUL) stands above other types of policies for its complexity, need for continual management, and high degree of financial risk and potential reward.

Put simply, VUL is not for everybody. Those simply looking to provide financial security to their beneficiaries might be best served by a term life insurance policy. Those who seek permanent life insurance with a cash value feature providing modest, but guaranteed, returns might be better served by a whole life insurance policy.

VUL, on the other hand, is for those with the mind and stomach of an investor, and who have a high tolerance for risk. VUL might also appeal to investors looking for a vehicle that provides tax-deferred growth. The cash value of a VUL is typically not taxable unless the policyholder makes a withdrawal or surrenders the policy.

And with its adjustable death benefit and premium, a VUL policy might also appeal to those looking for permanent life insurance with some flexible features.

What to consider with VUL

When considering VUL, you should understand a few of the policy’s features.

VUL is permanent life insurance

As a type of permanent life insurance, a VUL policy stays in effect until your death, provided you stay current on the policy premiums and don’t opt to surrender (cancel) the policy.

VUL death benefits can be adjusted

You can adjust the death benefit of a VUL as your needs change. This flexibility allows you to avoid being over- or under-insured regardless of what is happening in your life. If you adjust the death benefit, the premium will adjust accordingly.

VUL cash value growth is not guaranteed

VUL is really designed for those with investment savvy and some stomach for investment risk. If your investments grow in value, the policy’s cash value will grow accordingly. But if your investments perform poorly, the policy’s cash value will suffer.

VUL may be subject to numerous fees

A VUL may be subject to numerous fees, including mortality and expense risk charges, administrative fees, and fees related to the investments. Ideally, the cost of fees can be covered by the policy’s cash value. However, if the cash value drops, those fees will be added to the policy’s premium. If the cash value drops far enough and/or the fees grow enough, your policy may be at risk of lapsing altogether.

VUL may have tax implications

Cash value growth is tax deferred. You typically have to pay tax if you make a withdrawal in excess of the amount of premium paid, if a loan goes unpaid, or if the policy lapses or is surrendered. Policy death benefits are usually not taxable.

Pros and cons of variable universal life insurance

When considering your life insurance options, be sure you understand the pros and cons of VUL.

How to buy variable universal life insurance

VUL is more complex than other forms of life insurance. Your best bet, therefore, is to contact a licensed insurance agent who specializes in life insurance and sells VUL. And because VUL subaccounts are considered securities, the agent must also be registered with the Financial Industry Regulatory Authority (FINRA).

How much does variable universal life insurance cost?

The cost of VUL is tough to ballpark. As with any other type of life insurance, a VUL policy premium is partly based on the policyholder’s health, medical history, tobacco use, occupation, location, and other factors. With VUL, however, the cost also reflects fees related to the policy subaccounts, which can vary significantly from one policyholder to another.

The best way to get a sense of what you’ll pay is to contact a licensed agent who sells VUL insurance. They can discuss your needs and coverage options and help you better understand what you can expect to pay.

When to buy a variable universal life insurance

While almost anyone can buy life insurance, it’s often purchased by young adults who are accumulating large debts (such as a mortgage) and have savings needs (such as children’s education). It’s also commonly purchased by older adults to supplement their estate planning, or by business owners as a tool to help ensure business continuity if they should suddenly pass away.

Whatever your profile, a VUL should match your needs and goals. A licensed insurance agent who specializes in life insurance can help you determine if VUL is right for you.

What kind of investments can be made with a variable universal life insurance policy?

When you purchase a VUL insurance policy, you’ll have the opportunity to have your policy’s cash value invested in various subaccounts. These vary by insurer, and may include:

• Mutual funds.
• ETFs.
• Bonds.
• Individual stocks.
• Money market funds.

The insurer is required to provide a prospectus that outlines your subaccount investment options, including their risks and performance history. You can adjust your allocation as needed, but these moves may be subject to fees charged by the insurer.

Variable universal life vs. universal life

VUL and universal life (UL) policies are similar in many respects. Both are forms of permanent life insurance that remain in effect until your death, provided you maintain the premium payments. Both types offer the ability to adjust the death benefit/premium as needed. Finally, both types of policy offer a cash value feature—a living benefit that grows tax deferred and that you can access through loans or withdrawals.

A key difference, however, is how the cash value grows. Whereas a VUL offers the opportunity to select investments whose performance drives the cash value growth, UL does not have this feature. Instead, a UL offers a minimum guaranteed interest. UL also does not have the related fees, is less risky, and tends to be much less complex than VUL.

Tips for buying variable universal life insurance

As with any insurance purchase, it’s a good idea to check with multiple policy providers to make sure you’re getting the coverage that’s right for you. An independent agent who specializes in life insurance can help you settle on a VUL company that meets your needs.

When considering your VUL options, be sure to ask questions such as the following:

• Will this policy meet my needs for life insurance?
• Does this policy align with my financial goals?
• How much will this policy cost?
• What fees will I have to pay?
• What are the tax implications of the policy?
• What should I know about the investment prospectus?

Alternatives to variable universal life insurance

If VUL insurance doesn’t align with your needs and goals, or just seems a bit complex for your liking, know that you have many other options for life insurance. These include:

Term life insurance

Term life is the simplest, and typically the cheapest, form of life insurance. Lacking a cash value feature, it’s insurance, pure and simple. A term life policy stays in force for a set number of years—usually, 10, 20, or 30. You choose the term length when you buy the policy. If you should pass away during that term, your designated beneficiaries receive the policy’s death benefit. The death benefit and premium are fixed. Some term life policies can be converted to whole life upon the conclusion of the policy term.

Whole life insurance

Whole life is the most common form of cash value life insurance. As permanent insurance, a whole life policy stays in force until your death—there’s no set term, as with term life. The cash value earns modest but guaranteed interest paid by the insurer. The death benefit and premium are usually fixed.

Universal life insurance

Universal life is similar to whole life in some ways. Both are permanent insurance with cash value that grows at a guaranteed rate. Universal life has a flexible death benefit and premium, however, and the death benefit can be adjusted as your needs change.

TIME Stamp: Variable universal life is complex, and not for everybody

You have many life insurance options, ranging from simple and straightforward to complex. VUL is definitely on the more complex side of the ledger. It’s really designed for people who want permanent life insurance combined with an investment portfolio—one that must be actively managed. A licensed insurance agent can help you decide if it’s the right type of policy for you.

Frequently asked questions (FAQs)

Is variable universal life insurance a good investment?

Speak with a financial advisor to determine if VUL is a good investment. And be sure to consider the fees charged by the insurer to make changes to a policy’s portfolio subaccounts. You may find that it makes much more sense to invest more in vehicles such as a 401(K) (if you have access to one) or Roth IRA. However, if you’re maxed out on both of these, VUL is a third tax-advantaged option, as noted below.

Does variable universal life insurance have tax benefits?

The death benefit of a VUL is typically not taxed. For that reason, life insurance is often considered a tax shelter. Cash value growth also occurs on a tax-deferred basis, meaning you pay taxes only if you access funds through a withdrawal, policy surrender, or fail to pay back a policy loan.

Can you cash out a variable universal life insurance policy?

Yes. As with other types of cash value insurance, you can cash out a VUL policy. You can expect to receive the policy’s cash value, minus any outstanding loan balances or fees charged by the insurer.

What’s the difference between whole life insurance and variable universal life insurance?

Whole life and VUL insurance policies are both types of permanent insurance with a cash value feature. Whole life cash value grows from interest paid by the insurer—the growth is modest, but it is guaranteed. Whole life also has a fixed premium and fixed death benefit. The cash value for a VUL policy grows based on the performance of an investment portfolio chosen by the policyholder, thus offering a greater degree of risk and reward compared to whole life. The policyholder can also adjust the death benefit as their needs change.