Life insurance is a good way to provide a financial cushion for your loved ones after you pass, but it can have more uses than a death benefit payout. There are several types of life insurance products available that expand on basic term life insurance. The best feature may be the permanency.

Unlike term life insurance, which is only for a set period, such as 20 or 30 years, permanent life insurance, such as whole, universal and variable universal insurance, has no expiration date. Your policy is in force as long as you're alive and making premium payments. If you consider yourself an armchair investor or feel comfortable with equities, a variable universal life insurance policy allows you to add and invest excess cash.

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How does variable universal life insurance work?

A variable universal life insurance policy is a permanent life insurance option. Your premiums are based on the death benefit and cash value component. You can tap into a variable universal life insurance policy’s cash value while you’re alive. You may be able to borrow or make withdrawals.

As your cash value balance grows, your money can grow more through mutual funds or equities than with a whole life policy earning a nominal interest rate. But with greater rewards comes greater risks. The stock market can be volatile, affecting your returns.

Andy Bucklee, senior vice president and head of life and executive benefits distribution for Lincoln Financial Group, recommends universal life insurance for longer-term goals, such as retirement. 

"When planning for retirement, there are many considerations, such as lifestyles, wealth transfer and potential impacts of market volatility, taxes and longevity -- all of which are magnified in times of economic uncertainty."

Since a variable universal life insurance policy is invested in equities, including stocks and mutual funds, having other cash reserves will come in handy to ride out the market fluctuations during negative or bearish market conditions. That way, you don't have to draw on your cash value during poorly-performing periods when your value is down.

What are your investment options?

Most insurance companies provide dozens of investment options for variable universal life insurance. Your choices may include:

  • Mutual funds
  • Money market funds
  • Index funds, such as a Nasdaq or S&P 500 fund
  • Bonds

Variable universal life insurance offers flexible premiums

Besides the opportunity to grow cash value, you have more flexibility with paying your premiums than with a whole or term life insurance policy. 

You have a minimum and maximum payment range and can pay any amount within the limits. You can also pay your premiums using part (or all) of your cash value.

How you can use cash value

It's likely your cash value will experience an upside over time. The growth is tax-deferred, further accelerating appreciation.

 You can access the growing cash value of your variable universal life insurance policy for many purposes:

  • To make withdrawals
  • To pay your premiums
  • To increase the death benefit
  • To borrow against
  • To use as collateral for a loan
  • As the surrender value that you receive if you choose to end your policy

Variable universal life insurance pros and cons

Variable universal life insurance comes with greater risks and rewards than other types of life insurance. Therefore, it's important to understand the policies pros and cons:

Pros

  • Guaranteed coverage for life
  • Greater chance of growing cash value through investments
  • Tax-deferred growth
  • Flexible premiums
  • The death benefit can be adjusted without losing coverage
  • Borrowing against the cash value is possible
  • You'll have the potential to earn higher returns on your cash balance

 

Cons

  • Cash balance may fluctuate based on your investments
  • No guaranteed rate of return
  • Not for the risk-averse or those who don't understand how the stock market works
  • Overdrawing the cash balance can decrease the death benefit
  • Higher fees than other life insurance products
  • The insurance company keeps the cash value after you die
  • High surrender fees in the first several years

Variable universal life insurance death benefit

You may adjust the amount of the death benefit during the life of your variable universal life insurance policy. You'll probably need to pass a medical exam to increase the amount or pay surrender charges if you decrease the amount significantly.

A variable universal life insurance policy’s death benefit isn’t always guaranteed. Instead, the death benefit to beneficiaries could fluctuate depending on your investments. Be sure to ask the insurance company about a guarantee before you sign up. In some cases, you may have to pay higher premiums to guarantee that the death benefit won't be affected by the cash value account’s performance.

Whole life vs. variable universal life insurance

Depending on your level of knowledge about investing and your comfort with risk, variable universal life insurance may or may not be the best option for you. The death benefit, cash value and premiums could all fluctuate. 

But the return on your money can grow more than other types of permanent life insurance.

In contrast, whole life insurance comes with a fixed monthly premium for life, so you know what to expect. And the cash value earns a fixed rate of interest, similar to a money market bank account. 

A whole life policy’s growth potential may not be as big as variable universal life insurance, but your cash value and death benefit will be safe and predictable.

What is the difference between variable life insurance and variable universal life insurance? 

Variable life and variable universal life are similar in some ways. They’re both permanent life insurance, they both have cash value and they let you change your payments and death benefit amount. 

Variable life’s premiums are mostly invested in investment accounts, such as stocks, mutual funds, bonds and money markets. Variable life policies are riskier than variable universal life. Death benefits and cash value can change over time depending on investment performance. A variable life policy guarantees a death benefit, but if your investments perform poorly, you may have to pay higher premiums to assure the death benefit. 

Meanwhile, variable universal life combines variable and universal life. You can choose either a fixed death benefit or a variable death benefit. The variable death benefit is the policy’s cash value combined with the policy’s face value. Policyholders have more options to invest in these policies. Having more options can lead to more success, but failing investments can put you more at risk. 

Is variable universal life insurance a good investment?

Variable universal life insurance is a good investment if you've already maxed out your retirement accounts and still have excess cash you'd like to shelter from taxes. Otherwise, you may be better off investing in simpler, less expensive life insurance products, such as term or whole life, and invest the difference into an index fund through a brokerage.

Variable universal life insurance is more expensive than term or whole life insurance. Besides the policy fees, there are management fees and commissions associated with the investments you choose.