Variable Universal Life Insurance: In-Depth Guide and Things You Should Know Before Buying VUL

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It seems like life insurance companies are working tirelessly on developing their portfolio. That’s how, besides the traditional life insurance products you are used to (permanent life insurance, term life insurance, whole life insurance policy, etc.), you now heard of Variable Universal Life Insurance.

Sometimes it might feel overwhelming to understand how life insurance works, especially that there is an essential thing at stake – the quality of your life and taking care of your loved ones.

That’s why we prepared this comprehensive guide to Variable Universal Life Insurance, where we will share with you:

  • What is Variable Universal Life Insurance
  • How does Variable Universal Life Insurance policy works
  • What are the benefits of Variable Universal Life Insurance
  • What are the downsides of Variable Universal Life Insurance
  • What are the alternatives to Variable Universal Life Insurance.

By the end of this article, we intend to bring you closer to understanding how does Variable Universal Life Insurance work, and even more important – to know whether it is the best life insurance option for you.

What is Variable Universal Life Insurance?

Variable Universal Life Insurance (VUL) is a type of permanent life insurance policy with a built-in savings component that allows for the cash value investment.

Variable Universal Life Insurance (VUL) became the first choice for people who consider them investors, as it gives them control over how to invest the cash value in their policy. Due to its components, the Variable Universal Life Insurance policy differs from other life insurance policies and can be a powerful tool for building and protecting your finances.

The ‘variable’ in the Variable Universal Life Insurance refers to varying investment results in the fluctuating market. On the one hand, it provides increased flexibility and growth potential. However, on the other hand, market fluctuation could result in substantial loss, so policyholders should be careful and aware of the risks.

VUL policies are sold by prospectus, so a financial professional you are consulting should also provide you all the information needed.

Components of the Variable Universal Life Insurance policy

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You probably have a clearer picture of what VUL stands for. However, still, you don’t understand all of its components, such as death benefit, premium payments, cost of insurance, interest rate, insurance coverage, etc. The good news is we’re going to cover each of these elements so that you can get the complete picture.

Adjustable Premiums

A VUL policy offers a possibility of flexible premiums, which means that you can skip paying a premium or, at some point, even stop paying the premiums. The condition is that the cash value of your policy can cover the premium amount. In other words, the premiums would be paid out of your cash value.

The feature of adjustable premiums comes quite handy when not having enough funds to pay the premiums.

Investment options & Investment risk

A unique feature of the Variable Universal Life Insurance is that it allows you to invest in underlying sub-accounts offering various investment options.

You can choose from several investment options for your policy’s sub-accounts. People usually decide to invest in the financial market and the stock market. There is a possibility of transferring funds between investments without tax consequences.

The value of your policy’s subaccounts depends on the performance of the investments, meaning that if they do well – your policy’s cash value will increase. If they don’t do well, your policy’s cash value will decrease.

Bear in mind that there is an Investment risk as another component of Variable Universal Life Insurance. It is directly linked to the market risk, usual for this type of policy.

Increasing (or decreasing) death benefit

The death benefit is guaranteed with this type of life insurance policy. Another feature that makes it unique is that you have a possibility of increasing (or decreasing) your death benefit. In other words, you are eligible to request a death benefit increase or make a lump-sum payment to boost the policy’s cash value.

Policy loans

The Variable Universal Life Insurance policy gives you an option to withdraw funds or take out a loan against the cash value. This feature is seen in other permanent life insurances and the one policyholders are keen on.

Who should consider buying a Variable Universal Life Insurance policy?

This type of life insurance policy is suitable for people “seeking maximum flexibility”, as it can be a powerful tool for creating and protecting family wealth. Bear in mind that it is quite a complex life insurance product that requires intense investment monitoring.

To understand better if a Variable Universal Life Insurance policy is the right choice for you, you can ask yourself these questions:

  • Are you looking for ways to maximize the cash value growth potential?
  • Are you ready to challenge the risk tolerance that comes with underlying investment options?
  • Do you feel comfortable choosing and allocating investments?
  • Do you have clear investment objectives?
  • How important is flexibility to you?
  • Are you willing to commit to an annual policy review to manage your investment subaccounts and premium payments?
  • Are you willing to invest the time to evaluate policy options and customize a strategy to your needs?

If you had a positive answer to most of these questions, then Variable Universal Life Insurance might be a good choice for you. To help you become 100% certain in your decision, we will present you the pros and cons of this cash value life insurance.

Benefits of Variable Universal Life Insurance

There is a reason why many people choose a Variable Universal Life Insurance policy; actually – there is more than one. We highlighted the most important ones for you.

Death Benefit

Variable Universal Life Insurance is an investment product and a life insurance product at the same time. This means that one of the significant benefits is that there is an income tax-free death benefit payout to the insurance beneficiary. Avoiding a massive financial hardship can be a considerable benefit.

It is essential to mention that with a VUL policy, you are buying permanent life insurance. This means that you are buying insurance coverage for your entire life – as long as you keep paying your premiums regularly.

An additional benefit is that you can add rides to your VUL policy in case of certain health conditions. For example, If you are disabled, you can add long-term care riders to your VUL policy to add additional protection.

Last but not least – there is no endowment age with most VUL’s (the age at which the cash value equals the death benefit amount), allowing the policy to continue to grow as long as you live.

Flexible Premiums

We already talked about this but can’t omit to highlight it as a benefit of a VUL policy. There is a variety of options for you to use flexible premiums:

  • You can pay a portion of premiums – you can choose to pay an amount of your premium using cash and the other part using your cash value. This option is available once your cash value reaches a specific minimum size.
  • You can choose not to pay premiums – if your cash value is sufficient, you can choose to use it to pay the whole amount of premiums.
  • You can pay more than your target premium – if one of your main goals is cash value accumulation, you can choose to overfund your policy’s cash value early so that investment gains build up more quickly. This is a good option if your incomes are high enough to afford it, and you wish not to pay premiums later on, especially once you retire.

Flexible premiums enable you to adjust the premiums to your lifestyle and get the most out of the policy.

Entering Investment market with no Rate Cap

Policyholders can enter the market using their cash value with no rate cap.

If the mutual fund to which the cash value is invested returns a rate that exceeds 20%, the total amount is credited to the policy holder’s account (minus the management fees). The possibility of participating in the investment market and still receiving tax benefits is one of the main contributors to the growing demand for Variable Universal Life Insurance.

Tax advantages

All people have one thing in common – taxes as their nightmares. The good news is that with Variable Universal Life Insurance, you can expect various tax advantages.

We already mentioned that the death benefits are paid out to beneficiaries tax-free. All gains in cash value are tax-deferred, too. This means that your withdrawals will be tax-free on the basis, and you will be taxed on the growth of the account only if you withdraw beyond your base (premiums paid in).

An additional benefit is that you won’t be charged with early withdrawal penalties and the required minimum distributions that the IRS forces on the other tax-deferred products.

Policy Loans

The VUL policy is a cash value life insurance product. This means that the part of the premiums will always go to the cash value, which will grow over time.

The cash value portion guarantees that the premiums will stay the same and not rise high, resulting in the policy lapse. Further, the cash value may grow faster if the policyholder knows how to invest wisely.

The most significant advantage is that you do not have to withdraw your money to access it. Variable Universal Life Insurance Loans enable you to access your cash value without paying the taxes or reducing it.

You will be required to pay interest, but it is much lower than the interest rate a bank would charge you. You can choose not to return the loan, which would result in the death benefit being paid out minus the outstanding loans.

VUL policy loans come with less documentation and easier access to the cash value than other types of loans.

Downsides of Variable Universal Life Insurance

There are always two sides to the coin – in our case, there are a couple of downsides to the Variable Universal Life Insurance. Here are the things you should be aware of.

Increased risk in the market

Being able to enter the investment market is a significant benefit, but the price of it might be too high. Variable Universal Life does not offer guarantees.

The VUL policy allows you to invest in different financial markets, but you should bear in mind that those markets are not guaranteed. This means that you — as a policy owner — are required to accept the risk.

When the savings component of the insurance policy is separated from the death benefit, the risk is transferred to the policy owner. The value of your policy is directly linked to the value of the market. Unfortunately, with the market being unpredictable, you could easily find yourself losing your entire savings.

Higher cost

With increased benefits, you can always expect an increased price. With Variable Universal Life Insurance cash value being invested in the financial markets, additional fees are to be taken care of, such as those for policy charges and management fees.

In total, a Variable Universal Life Insurance costs more compared to some other life insurance policies.

Complexity

Variable Universal Life Insurance offers you various investment options – you can invest in mutual funds, money market funds, or even hedge funds. This comes with the responsibility to manage multiple investment accounts.

Generally speaking, owning a Variable Universal Life Insurance policy requires greater oversight and knowledge, meaning that it is not suitable for everyone.

Premiums may rise

There is a catch with your VUL policy that will occur if you lose your cash value or a substantial amount of cash value. The death benefit needs to be paid, and in cases like this, the insurer could increase your premiums to increase the chance of the death benefit being paid. If you don’t pay the increased premiums, the policy will likely lapse or will need to be modified.

No Guarantees

Variable Universal Life Insurance does not guarantee that the policy value is connected to the market value (if you choose to invest your cash value). This means that your death benefit depends on your skills to increase the cash value over the years.

Alternatives to Variable Universal Life Insurance

As you can see, Variable Universal Life Insurance is not an ide4al option. Luckily, there are alternatives to this policy. Here are the ones worthy of your attention.

Variable annuity vs. Variable Life Insurance

The main difference between a variable annuity and variable life insurance is reflected in the return of the investments. With the variable annuity, you can receive your investment back in a series of insurance payments. With VUL, on the other hand, you can make withdrawals or take out loans out of your cash value.

Another difference is that Variable annuities are restricted in a way that you would maybe have to pay a fee to make withdrawals before a certain age. The amount of cash value available only limits withdrawals from variable life insurance policies.

Variable Life Insurance vs. Whole Life Insurance

One thing is common – lifelong coverage. However, you will learn that Whole Life Insurance brings much more benefits and way less risk.

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With Whole Life Insurance, you can expect:

  • Level premiums – the amount of premiums remains the same throughout the policy duration.
  • Guaranteed death benefit – the death benefit is guaranteed and won’t fluctuate.
  • Guaranteed returns – your cash value continues to grow and is usually guaranteed to equal the policy’s death benefit when the policy matures (in case you turn 100)
  • Lower fees – whole life insurance has lower costs compared to variable universal life.

Five benefits of Whole Life Insurance

There are countless benefits of Whole Life Insurance. The most important one is that you can implement the Infinite banking concept and become your own bank. Here are some of the most significant benefits you can expect from Whole Life Insurance – if you start Infinite banking.

Control

If you implement the infinite banking concept, you sign the contract with the life insurance company only. As you don’t have to deal with other financial institutions, the control of your finances significantly increases.

Cash Value

Infinite banking is not only applicable when it comes to paying off your mortgage. On the contrary, infinite banking can help you bring cash value over time and build your wealth. Every single time you make a premium payment, cash value accumulates inside your policy. The nice thing about having this cash value is that you earn a guaranteed 4% interest on this money. An additional benefit is that you can access the cash value any time you want and use it for any needs you have at the given moment.

Dividends

This is the non-guaranteed portion of your contract premium, which is the dividends that are paid to you. As long as you work with a mutual insurance company, you could be paid a dividend each year. At the end of the year, if the insurance company is profitable and paid all their expenses, whatever is left is returned to the policy owners in the form of a dividend. We call that return a premium. The IRS does not tax you on these dividends, which is another bonus point regarding whole life insurance and infinite banking concept.

Riders

Riders are additional features and benefits that can be added to your policy for your specific needs. For instance, if you add a terminal illness rider and you’re diagnosed with a terminal illness, a portion of your death benefit can be utilized to cover your medical expenses. This is similar to a chronic illness rider, both of which give you benefits you can use while you’re still alive.

Tax Benefits

Because you put in after-tax dollars into a whole life policy, the cash value grows at a tax-free rate. That means that for the whole time you have your whole life insurance policy, you aren’t going to be taxed on any of the growth or even the cash value you utilize, as long as you request a loan. This brings a dose of security since you can never predict taxes in the future.

If you are interested in learning more about the benefits of whole life insurance, make sure you check our video and read our article on this exact topic.

And if you are wondering how you could use the concept of infinite banking in your life, make sure you go through 10 Ways to Use Infinite Banking.

Final thoughts

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We’ve come to the end of this article. So far, you know everything that you should know about Variable Universal Life Insurance.

You’ve also learned about the benefits of Whole Life Insurance, and you know our honest opinion – Whole Life Insurance can improve the quality of your life and help you build wealth.

If you want to keep learning and improving your finances, you can sign up for our premium membership. We are looking forward to seeing you at the Wealth Nation community!