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Variable universal life insurance is a kind of permanent life insurance that provides cash value in addition to a death benefit. You can invest the policy's cash value in subaccounts you select, such as stock funds, bond funds or mutual funds. You can also adjust the policy premiums and death benefit.
What Is Variable Universal Life Insurance?
Variable universal life (VUL) insurance is permanent life insurance that lasts your entire life as long as you pay your premiums. Like all life insurance, this insurance pays a death benefit to your beneficiaries upon your death. However, part of the premiums also goes into a cash value account that grows over time.
During your lifetime, you can borrow against the cash value account, withdraw money from it or use it to pay premiums. You also have the option to adjust your premiums and death benefit as your financial situation changes.
Variable universal life insurance is complex, involving risk and significant fees, so it's not suited for everyone. You may want to consider variable universal life insurance if you prefer taking a hands-on approach to investments, are comfortable with risk and have already maxed out your contributions to other tax-advantaged accounts such as 401(k) plans or individual retirement accounts (IRAs). You should also have a steady income that's adequate to cover the premiums over the long term.
Variable Universal Life vs. Universal Life Insurance
Closely related to variable universal life insurance, universal life insurance is permanent insurance that accumulates cash value you can use while you're alive. Universal life insurance also allows you to adjust your death benefit and premiums (it's sometimes called adjustable life insurance).
The key difference? Universal life insurance guarantees your cash value will grow at a minimum rate of interest. Variable universal life insurance, on the other hand, typically offers a wider range of investment choices, including options with fixed interest rates and options with variable interest rates.
How Variable Universal Life Insurance Works
Variable universal life insurance is permanent life insurance that lasts your entire life (or up to age 99, for some policies) as long as you pay your premiums. When you die with the policy in force, your beneficiary gets a tax-free death benefit. Part of your premium payment goes toward the death benefit; part goes toward fees and expenses; and part goes toward the cash value account.
You can choose where to invest the cash value of a VUL insurance policy. Typically, you can invest in one subaccount with a fixed interest rate and another subaccount that offers a variety of investments. Investment choices usually include:
- Mutual funds
- Money market accounts
- Bond funds
- Index funds
You can allocate your cash value among the subaccounts and investments according to your appetite for risk. Depending on your policy, you may be able to reallocate your cash among subaccounts or transfer money between subaccounts. There are typically restrictions on how often such changes can be made, and there may be fees involved.
Investing through a variable universal life insurance policy involves the same risks as investing individually and is regulated by federal securities laws. Your investments could perform well, or you could lose money.
Variable universal life policies let you lower your premiums when you need cash for other purposes (such as a child's wedding) and raise them when you're financially flush. However, you must maintain enough cash value to cover fees and insurance costs, or your policy could lapse.
If your financial situation changes, you can also reduce the death benefit, which generally lowers your premiums. Some policies let you increase the death benefit, although this may require a medical exam.
Variable Universal Life Example
Here's an example of how variable universal life insurance works.
Say you buy a VUL policy for an initial premium of $50,000 annually. You invest 10% of that amount in a fixed-interest subaccount guaranteeing returns of 3.9%, 50% in a stock fund and 40% in a bond fund. Over the first year, the stock fund earns a 10% return and the bond fund earns a 5.5% return. Here's how your returns shake out (minus fees and expenses):
- 10% in fixed-interest account: $5,000 invested = $195 return
- 50% in stock fund: $25,000 invested = $2,500 return
- 40% in bond fund at 5.5%: $20,000 invested = $1,100 return
- Total annual return: $3,795
Pros and Cons of Variable Universal Life Insurance
If you're considering variable universal life insurance, it's important to understand the key pros and cons.
| Pros | Cons |
|---|---|
| Lifetime coverage | High premiums and fees |
| Potential for high returns | Risk of losing money |
| Adjustable premiums and death benefit | Policy could lapse if cash value drops too low |
| Greater control of investments | Complex to understand and manage |
| Cash value accessible during your lifetime | Cash withdrawals or loans reduce death benefit |
| High returns may increase death benefit or allow you to reduce premiums | Poor returns could require premium increase or reducing death benefit |
How to Buy Variable Universal Life Insurance
If you're interested in purchasing variable universal life insurance, take these steps:
- Find an insurance professional. VUL insurance is a complex financial product, so you'll need the help of an insurance professional to buy a policy. You can work with an insurance broker who represents multiple insurance companies or with an insurance agent at a specific company. The insurance agent or broker will review your financial situation and goals and advise you on your VUL options.
- Review investment options. You'll receive a prospectus with details about the policy, investment options, fees and risks. Just as with any type of investment, you should review the prospectus carefully to make sure you understand the risks and costs.
- Research the insurance company. It's important to choose a financially stable insurance carrier. A credit rating agency such as AM Best can provide the company's financial ratings.
- Submit an application. This generally involves answering questions about your health, lifestyle, family health history, age, gender and weight. Most insurance carriers also require a medical exam.
- Receive approval and pay your premiums. Once your application is improved, the insurer will tell you how much coverage you qualify for, how much it costs and when premiums are due. Be sure to pay your premiums to start coverage.
Alternatives to Variable Universal Life Insurance
If variable universal life insurance doesn't fit your needs, there are several other life insurance options you can consider. Alternatives to variable universal life insurance include universal life insurance, whole life insurance and term life insurance.
Universal Life Insurance
Universal life insurance is permanent life insurance that lasts your whole life. Like variable universal life insurance, part of your premium builds cash value—generally at the same interest rate as a money market account. You can use this money during your lifetime, although doing so may decrease your death benefit if you don't pay back funds you withdraw or borrow.
When the policy's cash value hits a certain amount, you can tap the funds via withdrawal or loans, or use them to pay premiums. You also have the option to change your death benefit and premiums.
Whole Life Insurance
Whole life insurance is the simplest type of permanent life insurance. Protection lasts your entire life, or up to age 99, depending on your policy. Your death benefit and premiums typically don't change over the term of the policy.
Like variable universal life insurance, whole life insurance builds cash value tax-deferred. However, the interest rate of a whole life policy's cash value account is guaranteed, so you don't have to worry about losing money. As your policy's cash value grows, you can withdraw cash, borrow from the cash value account or use the money to pay premiums. Tapping cash value may reduce your death benefit unless you repay the funds.
Term Life Insurance
Unlike permanent coverage, term life insurance lasts for a set term, such as 10, 20 or 30 years. It builds no cash value, but your beneficiaries receive a death benefit if you die while your policy is active.
Premiums for term life insurance stay the same throughout the term, and are much more affordable than those for permanent life insurance. Once the term is up, premiums for renewing your policy or buying a new one typically rise substantially because you're a greater risk for the insurance company as you get older.
Learn more >> Which Is Better: Term or Whole Life Insurance?
The Bottom Line
When purchasing any type of life insurance, it's a good idea to check your credit score first. In most states, insurance carriers can take your credit-based insurance scores into account when pricing your premiums. Although not the same as consumer credit scores, these scores incorporate many of the same factors, such as your debt level and payment history.
The same tactics that can help improve your consumer credit score could increase your credit-based insurance score. Work on paying down debt and making timely bill payments, and you could pay less for variable universal life insurance.