What Is Variable Universal Life (VUL) Insurance?
Variable Universal Life Insurance is a life insurance policy that builds cash value. The accumulated cash in the policy can be invested in a number of different ways. The investments are chosen by the policyholder, in accordance with their financial goals and risk tolerance.
Variable universal policies differ from whole life policies because there is no “endowment” age. The endowment age – typically pegged at 100 – is the age of the policyholder at which the policy’s cash value will be exactly equal to the stated death benefit amount.
- Variable universal life (VUL) insurance is a type of policy that builds cash value.
- VUL premiums are very flexible, ranging from minimum monthly payments to maximum allowable monthly payments.
- A variable universal life policy offers the benefit of several tax advantages but comes with high administrative costs.
How Does Variable Universal Life Insurance Work?
The “universal” component means that the policyholder can flexibly make payments, with premiums that may range all the way up to the maximum allowed by the U.S. Internal Revenue Service. The only requirement for monthly premiums is that they meet a specified minimum amount required to keep the policy in force.
If there is sufficient cash value existing in the policy to cover the required minimum monthly premium amount, the insured is not required to make any payment at all. The minimum payment will simply be drawn from the policy’s existing cash value. (This directly contrasts with whole life insurance, which comes with fixed premium payments that need to be paid so that the policy doesn’t lapse.)
The “variable” component of the name is a reference to the fact that the policyholder can invest in a choice of instruments, such as stocks and bonds, and, therefore, the investment returns can, and will, vary. Some policies offer more than 30 separate sub-accounts for investing in virtually any type of asset class.
Structure of VUL Insurance
To make it more simple, variable universal life insurance is a combination of both a savings element and a death benefit. The VUL policy allows for more flexibility so it can be managed easier. Premiums are paid into the savings component. The savings component, itself, is further broken down into sub-accounts, which can be invested in a wide range of assets, as noted above.
Tax Advantages of VUL Insurance
There are several tax advantages that come with a variable universal life policy. In fact, the tax advantages are one of the primary reasons for choosing a VUL policy over other life insurance options. The following are key tax advantages offered by VUL policies:
- The insured can withdraw money from the policy, tax-free, in the form of policy loans (up to the total amount of the policy’s accumulated cash value).
- Taxes on the gains from policy investments are deferred until the policyholder takes withdrawals of the policy’s cash value in retirement.
- Death benefits paid out to the insured’s beneficiaries are not subject to income tax (although they may be subject to estate taxes in some states).
The Downside of VUL Insurance
While variable universal life insurance policies offer flexibility and significant tax benefits, they typically include very high administrative costs (up to several thousand dollars). VUL policies are high commission sales products for insurance agents. The generous commissions must be covered by the administrative costs for the policy.
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