What Is Variable Universal Life Insurance?

Variable universal life (VUL) insurance is a life insurance policy with lifelong coverage, a tax-free death benefit and flexible premiums that you can increase or decrease over the policy life. These policies also have a cash value component that can grow based on market performance, offering a higher growth potential than other types of life insurance policies. The accumulated cash value can be used as collateral for a loan or cashed out early by surrendering the policy.

Universal life insurance isn’t for everybody since you can actually lose money if your underlying investments perform poorly. Find out if a variable universal life insurance policy is right for you.

On This Page

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  How Does Variable Universal Life Insurance Work?

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  How Do Variable Universal Life Insurance Premium Payments Work?

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  How Does Investing With Variable Universal Life Insurance Work?

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  Variable Universal Life vs. Universal Life vs. Variable Life

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  Variable Universal Life vs. Whole Life vs. Term Life

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  What Are the Pros and Cons of Variable Universal Life Insurance?

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  Is a Variable Universal Life Insurance Policy For Me?

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  FAQs

How Does Variable Universal Life Insurance Work?

Variable universal life insurance comes with permanent life coverage, which means your beneficiaries are entitled to a tax-free death benefit (cash payout) after you die, up to age 121. This coverage remains in effect, so long as you fulfill your premium payments. Otherwise, your policy will lapse after excessive missed payments and your beneficiaries will not receive any cash payout in the event of your death.

How Do Variable Universal Life Insurance Premium Payments Work?

Similar to a universal life policy, VUL insurance comes with flexible premiums. Policyholders can increase or decrease the premium amounts within limits, which can help them cover necessary expenses during financially challenging periods, such as being laid off from work. Alternatively, you can increase your premiums to maximize your cash value growth potential.

How Does Investing With Variable Universal Life Insurance Work?

VUL policies have a cash value component that will accumulate equity with each premium payment. A portion of your premiums is deposited in an interest-earning savings account or an investment account that grows based on market performance or a combination of both.

Since there is a market element to your cash value growth, VUL policies have a higher growth potential than whole life policies, which earn interest at a guaranteed but lower rate. However, high-risk investments may increase your rate of return but can also result in financial loss if the market performs poorly.

Tax-Deferred Growth

Cash value grows tax-deferred, which means the accrued value is not taxed unless you surrender the policy and cash it out (in which case your beneficiaries will not receive a death benefit when you die). Tax-deferred growth gains value more quickly than tax-free cash value income, which is taxed annually.

Here’s an example of how growth would differ between the two types of accounts. Each account experienced a 3% annual rate of return with $100 monthly contributions over 50 years. Both accounts had a starting balance of $0.

Keep in mind that only the cash value that exceeds the policy basis (the total premiums you’ve paid into your policy) must be reported to the IRS as taxable income. For example, if you’ve paid $10,000 in premiums and your cash value account carries $15,000, then $5,000 will be taxable.

What Can You Do With Cash Value?

Once your cash value reaches a certain threshold and starts generating income, it can eventually be used to pay premiums and policy fees. VUL policies carry additional fees, some include investment portfolio management expenses. However, if there is no cash value to cover your policy expenses, your policy may lapse and your beneficiaries will not receive any cash payout after you die.

You may take out a loan with the insurance company using the cash value as collateral. Over time, your cash value account can grow considerably and the amount may be useful for financing major life expenses, like your child’s college tuition or a down payment on a home. Like any loan, you will need to repay the loan plus interest or the outstanding balance will be deducted from your death benefits, resulting in a small cash payout for your beneficiaries.

Finally, you can completely withdraw your cash value by surrendering the policy. Surrendering the policy means canceling your death benefits so your beneficiaries will not receive any cash payout after you die. Keep in mind that surrender fees may apply and early cash-outs may create a taxable event.

Variable Universal Life vs. Universal Life vs. Variable Life

Differences in Premium

Premiums for variable universal and universal life policies can be increased or decreased over the policy life. Finances can shift over your lifetime and flexible premiums can help you meet your changing budgetary needs.

Variable life insurance premiums are fixed and will not change throughout the policy life. Payments are fixed, which can make them easy to incorporate into a long-term budget.

Differences in Death Benefits

Variable universal and universal life insurance have fixed death benefits. Whatever coverage amount you purchased when opening the policy will be what your beneficiaries receive after you die.

Death benefits on variable life policies, however, can fluctuate based on how your cash value investments perform. Variable life policies typically have a minimum death benefit, so your losses will have a floor — failure to pay your premiums and policy fees will surrender the policy, however.

Differences in Cash Value Growth

Both VUL and variable life policies have a higher cash value growth potential than universal policies because the rate of return is based on the market performance of your underlying investments. If your investments excel, then you can expect a higher rate of return. However, high reward is paired with high risk and you may lose money if market conditions are poor.

Universal life policies may have greater cash value growth potential than a whole life policy because returns may be based on investment performance or a guaranteed minimum interest rate. However, growth potential is generally lower than VUL and variable insurance.

Variable Universal Life vs. Whole Life vs. Term Life

Differences in Premium

VUL policies have flexible premium payments, allowing you to increase or decrease your payments within limits — helpful if you’re undergoing temporary financial hardship.

Whole life and term life insurance policies have fixed premiums and do not change over the policy life. However, term life premiums will typically increase if the term expires and you either renew the term or convert the policy into a permanent life insurance policy. Not all term life policies can be converted, so be sure to confirm with your insurance agent before purchasing the policy if this is what you may want to do.

Differences in Death Benefits

Variable universal, whole life and term life policies have fixed death benefits. Your beneficiaries are entitled to the benefit amount purchased when opening the policy, so long as you die within the life insurance coverage period and continue paying your premiums.

Differences in Cash Value Growth

VUL policies have higher growth potential than whole life policies because the underlying investments are based on market performance. If the market performs well, your policy’s cash value grows at a higher rate. However, you may lose money if your investments underperform.

Whole life policies generally earn interest at a low but guaranteed rate. Whole life policies will accumulate cash over time — albeit slowly — so long as you maintain your premiums.

Term life insurance policies do not have any cash value component.

What Are the Pros and Cons of Variable Universal Life Insurance?

Pros

• Lifelong coverage: Your beneficiaries are entitled to a cash payout at any age you die, assuming you keep up with your premium payments before your death.
• Greater control over your investments: You can follow a conservative or high-risk, high-return investment strategy based on what underlying investment options your insurance company offers.
• Higher growth potential than whole life policy: Your cash value growth is based on market performance, which can result in a higher rate of return if your investments perform well. Whole life insurance policies, on the other hand, typically earn interest at a guaranteed but low rate.
• Fixed death benefit: Your death benefit will not decrease if your investments underperform, unlike a variable life policy.
• Flexible premiums: Increasing or decreasing your premiums (within limits) can be useful if you have fluctuating income or your budget is stretched thin after losing your job, paying for a wedding or some other costly event.

Cons

• Higher risk of losing money: Higher growth potential is also paired with a higher risk of losing money if your investment options perform poorly. If your cash value isn’t enough to cover your fees, you may have to pay out of pocket or risk your policy lapsing and surrendering your death benefits.
• Fees: VUL policies carry various fees — some of them related to managing your investments — that can eat into your cash value growth.
• Complex: With different investment options, flexible premiums and investment-related fees, there are far more considerations to juggle in a variable universal policy than a standard 20-year term life policy.

Is a Variable Universal Life Insurance Policy For Me?

VUL policies are ideal for individuals that want lifelong coverage and some investment experience because your investment choices will affect your policy’s cash value growth. Policyholders who understand the value of each investment security option available are better able to maximize their rate of return. Those considering VUL policies should also understand that there is a higher risk of financial loss if your investments underperform.

Those seeking lower but guaranteed returns may want to look at other types of life insurance, like a whole life policy. As long as premiums and policy fees are covered, whole life policies will slowly but steadily grow equity over time.

Is VUL is right for? If it is outside your comfort zone, SmartFinancial can help you explore other life insurance options, like whole life or term life insurance.

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