Shopping for life insurance seems straightforward, but buying the right policy means knowing what each type of coverage offers. For example, variable universal life insurance provides a death benefit and includes an investment option, while another might offer the death benefit only. Here we'll look at what makes a VUL policy a unique life insurance product, and see how it differs from other types of permanent insurance.
What is variable universal life (VUL) insurance?
A variable universal life (VUL) policy is a type of permanent life insurance that includes policy cash value, variable investment options, flexible premiums, and a flexible death benefit that can be used in more than one way. A variable universal life policy offers lifelong coverage, as long as the premium is paid.
How does variable universal life (VUL) insurance work?
Variable universal life insurance is a bit of a unicorn. At first glance, it looks a lot like any other permanent life insurance policy, but there are unique features that set it apart.
Flexibility
Unlike with some types of coverage, a policyholder can adjust the amount of the premium instead of paying the same amount each year. Some years, the policyholder may want to pay more than their policy requires in order to build more equity. Other years, they may run into an emergency or unexpected expense and need to pay less. Policyholders can alter the amounts they pay as long as there is enough cash value in the account to cover policy expenses.
Accumulates cash value
A variable universal life insurance policy accumulates cash value that can grow over time -- depending on the performance of the investment options it is tied to. This cash value grows tax-deferred, meaning the policyholder does not owe taxes until they take withdrawals.
The policyholder decides where the cash goes
VUL insurance policies accumulate cash value. While some types of insurance are fully managed by a financial professional hired by the insurance company, the policyholder can determine where the money in a VUL should go, choosing investment options based on their preferred level of risk.
Lasts a lifetime
Unlike term life insurance, a variable universal policy provides coverage for the policyholder's entire life, as long as premium payments are current.
In a bull market, when the economy is strong and stock values are on the rise, a variable universal life insurance policy is likely to generate a strong return. On the other hand, when stock values are down in a bear market, the policyholder risks losing value.
Can borrow from accumulated cash
Once enough cash has accumulated, it is possible to borrow money via the policy. However, it can take years to build up enough cash value to borrow. Plus, borrowing from the cash value may leave too little in reserve to cover the premium if the policyholder runs into trouble and cannot make the monthly payments.
May include a surrender period
Variable universal life policies typically include what's called a "surrender period." While the length of the surrender period varies by carrier, it can be as long as 15 years. The policyholder is charged a surrender fee for canceling the policy before that time has passed.
One of the reasons to read a variable universal life policy carefully before signing is to learn the amount of any surrender fee. Let's say someone has $50,000 built up in their policy, and their surrender fee is 3%. If they surrender the policy early, the life insurance company keeps $1,500 of the $50,000 ($50,000 x 0.03 = $1,500).
Gains are taxed
Taxes are due on gains whenever the policyholder withdraws more than they've paid in premiums. Let's say someone has paid $40,000 in premiums and withdraws $50,000. They are responsible for paying taxes on the difference between what they've paid and the amount they withdraw -- in this case, $10,000.
Proceeds are taxed at the normal income tax rate. So if the policyholder's income puts them in the 24% tax bracket, they pay 24% of the proceeds in taxes. In this case, taxes would amount to $2,400 ($10,000 x 0.24 = $2,400).
