A Guide to Variable Universal Life Insurance

Universal life insurance is a type of permanent life insurance created in the 1980s to accommodate investment savings. There are several variations of universal life policies, and one of these is variable universal life insurance. So what is variable universal life insurance? This article answers that question and shows why this policy is a poor investment and policy. 

What Is Variable Universal Life Insurance

A variable universal life insurance (VUL) policy is similar to other universal life insurance policies in that it’s a permanent plan including a death benefit with the potential to accumulate cash value. VUL policies also have flexible premiums, like other universal life policies. The main difference is that VUL policies allow you to put some or even all of the cash value in your policy into variable accounts of investment funds, such as stocks and bonds. Many people are drawn to this policy because they’re able to carry a death benefit and invest. 

These subaccounts are where the policy gets its name. Because these accounts are tied to the market, there’s variation in what returns you get. The market is always fluctuating, and with that fluctuation, your policy will be affected. Sometimes the market performs well, and you can get significant returns. But when the market doesn’t perform, you could also suffer substantial losses. 

How Variable Universal Life Insurance Works

When you buy a VUL, you pay a premium, and the premium goes toward the savings component of the policy. From there, a determined chunk of that premium will go toward your subaccounts that are tied to the stock market. The insurance provider will also deduct the cost of the death benefit and administrative fees from this premium. 

Each of the subaccounts is structured similarly to a family of mutual funds. There’s often an array of stocks and bonds with a money market option as well. The insurers for this type of policy have to be certified or hold a securities license because the policy delves into the stock market so much. The insurer often guides where the cash value goes, but you do retain some control of how your cash value is invested. 

What Is the Difference Between VUL and Whole Life? 

A variable universal life insurance policy is different from a whole life policy, even though they are both permanent life insurance. These are some of the key differences between the two types of policies:

  • VUL policies have a flexible premium while whole life has a fixed premium. You or the insurance company are able to adjust the premiums even after the policy is purchased. 
  • VUL policies are tied to the stock market with variable returns depending on how the market performs while whole life has a guaranteed cash value accumulation through equity. 
  • The subaccounts in a VUL policy are separate accounts. The cash value in these accounts is just cash. It is not equity like cash value in whole life insurance policies. 

While whole life and variable universal life are both classified as permanent insurance, there are key differences in how they accumulate cash value. The key difference between these two is that VUL policies are variable while whole life policies are guaranteed. 

The Problems with Variable Universal Life Insurance

Variable universal life insurance was designed to combine flexible premiums, a death benefit, and the opportunity to invest. But in practice, this insurance has some key problems that are important to understand: 

  • VUL insurance has enormous amounts of fees. While a whole life policy might deduct a flat $75 fee, VUL fees can be extensive. Often 6% of your premium payments go to the insurance company initially. Then each subaccount has a fee associated with it that is also deducted from your cash value. Finally, there’s the flat policy fee every life insurance policy has. When all of these fees are added up, it’s unusual to see fees less than $250. And these fees come from your cash value, which then hinders how much you’re able to gain from your investments. 
  • VUL insurance isn’t truly permanent life insurance. Though VUL is categorized as permanent, that’s not necessarily accurate. Often a VUL actually includes term insurance, unless you pay an additional fee to make it permanent. If you don’t pay the fee to make it permanent, you’re faced with increasing premiums as the term insurance costs increase. As you age, term insurance increases, and a VUL policy may as well. The increasing cost can also chip away at your cash value and leave you with little to no cash value at the end of the policy. 
  • VUL insurance very often doesn’t perform. When your cash value is tied to a fluctuating market, you very often get little in return. Your subaccounts may do well as the market does well, but you can still end up paying more in premiums and fees than you gain from your subaccounts. After 20–25 years of your policy, you might find yourself with no cash value, even after all the premiums and fees you paid over the decades. This can be detrimental if you were using your policy to save for retirement. By the time you are ready for retirement, your policy might have no cash value. 
  • VUL insurance transfers the insurance risk back to the owner. Usually you choose to take out an insurance policy to reduce some of the risk of owning property or potentially dying. But when you choose variable universal life insurance, you’re not transferring all of that risk onto the insurance company. With VUL the insurance companies are able to legally transfer the risk back to you. That’s why these policies are appealing to insurers and are still sold today. With whole life insurance, the insurance company carries your risk instead. 

Alternatives to Variable Universal Life Insurance

With all the risks associated with variable universal life insurance, choosing this type of policy is most often a poor investment. But VUL insurance isn’t the only option. Here are some alternative options to variable universal life: 

  • Choose a whole life policy. If you’re looking for permanent life insurance, whole life provides the guarantees without the risk. You’ll accumulate cash value guaranteed and still have a death benefit at any point should you need it. You’ll also be able to use the cash value during your lifetime. 
  • Some people leverage whole life insurance cash values to invest in the stock market on their own. VUL policies have many fees that you can bypass if you do your own investing. 
  • Invest and buy term insurance. If you do need some life insurance coverage but don’t want permanent coverage, you can buy term insurance and invest instead. We don’t recommend this strategy because of the long term risks that aren’t covered with this strategy, but if someone is inclined to use this highly promoted financial plan, we recommend that the buy convertible term insurance so they can convert it to permanent whole life if they need to carry insurance longer than they thought they would.  The buy term and invest the difference strategy isn’t as fruitful in the long run as a whole life policy, but it’s still more financially secure than VUL insurance

If you’re unsure about what type of life insurance you want, we can make you a personal illustration so you can see what a policy for you would look like. To see an illustration customized for you,  schedule a personal appointment here.

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