What is variable universal life insurance?

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Life insurance provides 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 offer more than just the death benefit.

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 policy allows you to add and invest excess cash.

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 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.

Andrew 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.

How can you invest with variable universal life insurance?

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

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 limits. You can also pay your premiums using part (or all) of your cash value.

How you can use the cash value of variable universal life insurance

Your cash value will experience an upside over time, though this upside may take decades. 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.

Pros and cons of variable universal life insurance

Variable universal life insurance comes with greater risks and rewards than other types of life insurance. It’s important to understand the pros and cons of the policies.

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
Involves high risk
Policyholders must understand and monitor the stock market
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

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How the death benefit works for a variable universal life insurance policy

VUL policies allow the policyholders to adjust the amount of the death benefit during the life of their 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 payout to beneficiaries fluctuates 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.

Alternatives to variable universal life insurance

Unlike most other types, variable universal plans allow the policyholder to choose how much they want to contribute each month or year and invest that money in stocks, bonds, mutual funds or any other investment option available on the market. That amount will fluctuate with changes in interest rates, so it can grow as well as reduce when rates go down. Variable universal life insurance offers are typically more expensive than traditional whole-life policies because you pay for flexibility over time rather than security later.

However, if you’re looking for something more predictable with guaranteed rates, then fixed policies might work for you. Here are some of the alternatives to variable universal life insurance-

Final expense life insurance: Final expense policy covers the costs associated with end-of-life expenses, such as funeral and medical bills. The coverage is much smaller than any other types of life insurance policies.
Term life insurance: Term life insurance is more cost-effective and straightforward than variable universal life insurance. There is no cash value, and your beneficiaries receive a straightforward payout.
Whole life insurance: A whole life policy lasts your entire life and has a cash value, but doesn’t come with the same risks as variable universal life insurance.

What is the difference between variable life 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 policies combine 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.

You should speak to a certified financial planner before purchasing a variable universal life insurance. It’s a complicated insurance policy that requires a lot of planning.

Frequently asked questions about variable universal life insurance

What is the minimum amount of coverage required for variable universal life insurance?

The minimum coverage for variable universal life insurance varies from company to company, but it typically requires a minimum $50,000 worth of coverage per insured person.

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

One of the most important differences between universal and variable life insurance is that with a variable plan, you have more control over your cash value growth.

Variable universal life (VUL) is a type of life insurance policy that combines the benefits of both variable universal life (VUL) and flexible variable life or universal life insurance. This kind of policy offers more options than standard plans, giving its holders flexibility in coverage changes with ease.

Whereas universal life insurance policies pay a death benefit upon your death and accumulate cash value during your lifetime. The accumulated cash is based on both what you paid in premiums as well as current interest rates decided by your insurance company.

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Cynthia Bowman

Contributing Researcher

Cynthia Paez Bowman is a personal finance writer with degrees from American University in International Business and Journalism. Her work has been featured in MSN, Brex, Bankrate, Freshome, The Simple Dollar, GOBankingRates, and more. Cynthia is based between Las Vegas and Europe. In her spare time, she travels throughout Africa and the Middle East helping women entrepreneurs develop and grow their businesses.