When shopping for a life insurance policy, you may have more options than you realize. While all life insurance policies offer a death benefit, if you are in the market for a life insurance policy that can offer flexible premiums and opportunities for cash value growth, you may be interested in a variable universal life insurance policy. However, of the different kinds of life insurance, variable universal policies may be more difficult to understand than more straightforward term and whole life policies. Bankrate is here to help. Our editorial team has vast insurance industry experience, and we are dedicated to demystifying the insurance shopping process to help our readers make informed financial decisions. Below, we have outlined what you should know about variable universal life insurance.

Variable universal life insurance policies

A variable universal life (VUL) insurance policy is a type of permanent life insurance that offers both a death benefit and a cash value component. Permanent life insurance includes various types; here are some common ones:

  • Whole life insurance: This policy comes with fixed premiums and provides a modest guaranteed interest rate, resulting in a steady but slow growth of cash value. Some whole life policies, called participating whole life, can also earn dividends.
  • Universal life insurance (UL): With this policy, your policy is set up with projected level premiums, but allows for flexibility on the amount you decide to pay. It earns interest based on the insurance company’s investments, and it has a minimum guaranteed crediting rate.
  • Indexed universal life insurance (IUL): This universal policy provides the same flexibility as a traditional UL, but the cash value is linked to market index funds, like the Nasdaq Composite or S&P 500.
  • Variable life insurance (VL): This type features fixed premiums but does not offer guaranteed interest earnings. Instead, the policyowner can control the investment options.
  • Variable universal life insurance (VUL): This policy offers the flexibility of having either fixed or adjustable premiums. The policyowner selects the investments, which are usually managed by the insurance company. However, there are no guarantees on interest rates or cash value.

VUL insurance is notably flexible among permanent life insurance options. It allows you to adjust the death benefit amount and modify your premium payments once you’ve built up sufficient cash value. Additionally, the cash value of the policy can potentially grow more by investing in sub-accounts that reflect investment accounts.

It’s important to understand that with the potential for higher returns comes increased risk. Just like any other stock market investment, the cash value in a VUL policy can fluctuate, resulting in possible gains or losses. These policies are not ideal for short-term investments as the portfolio’s value can change daily, which might not suit investors who are uncomfortable with frequent fluctuations. VUL policies also have high surrender charges that decline over the first 10-15 years of the policy, which impacts liquidity.

Because VUL policies are considered securities products, they can’t be sold without a special document called a prospectus. The SEC requires this document to explain all the important details of the policy, like costs, investment choices, benefits and your rights as the policyholder.

What are variable universal life insurance subaccounts?

Investment subaccounts for a variable universal life insurance policy are where you invest your cash value. With most variable universal policies, these investments typically include stock funds, bond funds and money market funds. Your policy also offers investments into fixed accounts with guaranteed minimum interest. Typically, your subaccounts will be subject to a management fee, which you can expect to hover between .05 percent and 2 percent, depending on your policy.

It can be helpful to think of subaccounts like a mutual fund with one key difference: unlike a mutual fund, subaccounts are tax-deferred. And you may not have to wait to access your cash value; with a variable universal life insurance policy, you may be able to borrow against or withdraw funds from your subaccounts.

Benefits of variable universal life insurance

A variable universal life insurance policy isn’t necessarily for everyone, but it may be a good option if you have some investment knowledge and would like to maximize earnings on the cash you’re accruing. Before diving into some benefits, here’s a quick look at the pros and cons of VUL policies.

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  • Flexible premiums: Adjust payments to fit your financial situation
  • Investment control: Choose where to invest cash value
  • Tax advantages: Tax-deferred growth and usually tax-free death benefit
  • Adjustable death benefit: Modify the benefit amount as needed
  • Potential for high returns: Investing in the market aggressively could lead to higher cash value growth
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  • Investment risk: Cash value can decrease based on market performance
  • Complexity: Requires careful management and understanding
  • Costs: Various fees can impact overall returns
  • No guarantees: No guaranteed interest rates or cash value. The exception is if you choose to direct all cash value to the fixed account option.
  • Cash value risk: You could lose your cash value, which might reduce the death benefit or cause the policy to terminate.

Guaranteed death benefit

VUL policies typically offer the option of level or increasing death benefits, similar to traditional universal life insurance policies. Your VUL policy will have two components: the death benefit and the cash value. Essentially, the policy will either pay out the cash value to the policyowner or it will pay a death benefit to the policy beneficiaries upon the death of the insured. No cash value is available when the death benefit is paid out. An exception to this rule is if you have an increasing death benefit policy where the cash value is added to the initial death benefit.

Flexible premium payments

Unlike most life insurance policies with fixed monthly premiums, variable universal life insurance typically allows you to adjust your premium payments based on your financial situation and investment goals. VUL policies generally offer three payment options:

  1. Target premium payments: These act like fixed premiums where you pay the same amount at regular intervals. This approach is intended to keep your policy active until around age 95 or 100. However, this premium amount isn’t guaranteed, and if your cash value depletes significantly, you might need to pay higher premiums or reduce your death benefit.
  2. Minimum premium payments: After the first year, you can opt to make minimum payments. The policy will use the cash value to cover the costs, but if the cash value runs out, the policy could be terminated.
  3. Prefunding: This involves paying higher premiums early on to build up your cash value more quickly. This can lead to faster accumulation of earnings, allowing you to later use the cash value to cover the policy costs or access it through loans or withdrawals.

Additionally, VUL policyholders have the flexibility to make extra premium payments at any time or even skip payments as needed, which can be particularly beneficial as financial circumstances change over time.

More control and greater growth

In other permanent life insurance policies, the cash value typically earns a modest amount of interest. With a VUL policy, you have more control over how your cash value grows. You can choose to invest the cash value in subaccounts, which could potentially lead to greater growth.

However, with the potential for higher returns comes higher risk. Since there are limited guarantees with a VUL, the cash value can fluctuate based on the performance of your investments. This means you could lose some or all of your cash value, which could, in turn, reduce the death benefit or cause the policy to terminate.

Tax-deferred earnings

With a VUL policy, your beneficiaries typically receive the death benefit free from federal income taxes. Additionally, the earnings from your invested cash value are usually tax-deferred, which means you only pay federal taxes under specific conditions. Here’s a breakdown of what this entails:

  • Tax on gains: You only pay federal taxes on the amount you withdraw if the earnings are more than what you’ve paid into the policy (your “cost basis”).
  • Borrowing: You can borrow against your policy’s cash value without paying taxes. However, if your policy lapses or ends while you still owe money, you might have to pay taxes on the unpaid amount. If there are outstanding loans at death, the balance will be deducted from the death benefit.
  • 7-pay test: This test, similar to what is laid out in IRS Section 7702, ensures your policy isn’t funded too quickly and is used mainly for protection rather than as an investment. If your policy fails this test, it might lose its tax benefits and be classified as a Modified Endowment Contract (MEC), which has different tax rules.

Who might benefit from a variable universal life policy?

There are three types of people who might benefit most from a variable universal life policy:

  • Seasoned investors: A variable universal insurance policy is more complex than other life insurance products. Investors who understand how the stock market and mutual funds work and the risk involved with a VUL could benefit from this type of life insurance policy.
  • High-net-worth individuals: Estate planning can be crucial to minimize your heir’s tax bill when you pass. Depending on your state’s estate tax laws at the time of your death, you could pass along a nice nest egg to your heirs via your variable universal life insurance policy, tax-free.
  • People who have maxed out retirement: If your 401(k) and IRA accounts have already been maxed out for the year, a variable universal insurance policy may be just the place to put a lump sum of cash. Given the higher fees and cost of insurance associated with a VUL, this option likely doesn’t make sense unless you max out other retirement plan options first.

The intricacies of a variable universal life insurance policy may feel overwhelming to some. If you are looking for a permanent life insurance policy that offers cash value increases and flexible premiums similar to those of a variable universal insurance policy — but is slightly easier to understand — a universal life insurance policy may be worth considering.

When you shop for life insurance quotes, it’s important that you understand how your premium, death benefit and cash values work together. With a variable policy, especially, keeping track of your cash value is key to ensuring your policy doesn’t risk termination.

Frequently asked questions

  • Term life insurance is a temporary life insurance solution. It’s less expensive but is only available for a set term, typically 10, 20 or 30 years. Variable universal life insurance is a form of permanent life insurance that’s good as long as you continue to pay your premiums.
  • It is possible to cash out any permanent life insurance policy, variable universal policies included. The exact cash surrender value — how much your insurance provider will give you if you cancel your policy — will depend on a handful of details, such as how long your policy was active, the amount of money poured into your account and the potential fees or penalties deducted for surrendering the policy. Variable universal life policies have high surrender charges that decline over the first 10-15 years of the policy.
  • Permanent life insurance has two parts: the death benefit and the cash value portion. The death benefit is reserved as a payout to your beneficiaries after you pass away. In contrast, you can withdraw and borrow from the cash value portion throughout the life of the policy. Note that any amount withdrawn or outstanding loans, plus accrued interest, will be deducted from the death benefit before it’s paid out to beneficiaries.
  • Both whole life insurance and VUL insurance are types of permanent life insurance designed to provide long-term coverage (typically maximum coverage ages of 95 to 121) as long as premiums are paid. Whole life insurance has fixed premiums for the life of the policy and a cash value that grows steadily with a guaranteed, albeit modest, interest rate. On the other hand, VUL insurance offers flexible premiums that can be adjusted over time. The cash value in a VUL policy can be invested in subaccounts that mimic stocks and bonds, potentially achieving greater growth. However, this also introduces higher risk, as the cash value can fluctuate with market performance. The variable universal life insurance average interest rate varies widely depending on the chosen investments and market conditions, making it essential for policyholders to carefully consider their risk tolerance and financial goals. It’s important to monitor your VUL policies on an annual basis by requesting in-force illustrations from your insurance agent. In addition to asking a licensed agent questions to better understand potential returns and premium options, using a variable universal life insurance calculator could be helpful.