Variable Universal Life Insurance: How It Works, Features, and Key Considerations
Variable universal life insurance is a form of permanent life insurance that stays in force for the policyholder’s entire life, provided the policy remains adequately funded. Like universal life insurance, a variable universal life insurance policy offers flexible premiums and an adjustable death benefit, allowing the policyholder to decide how much to contribute above a required minimum. This flexibility also allows the policyholder to influence the face amount of the policy.
For individuals and families in Fort Myers and across Southwest Florida evaluating permanent life insurance options, understanding how variable universal life insurance works is an important step before committing to a policy.
What Makes Variable Universal Life Insurance Different
The key difference between variable universal life insurance and other types of permanent life insurance is investment control. With a VUL policy, the policyholder directs how premiums are invested, offering access to the potentially higher returns available through the financial markets.
This same feature also introduces risk: investment performance can underperform compared to other, more conservative life insurance products. Because of this, VUL insurance is generally best understood as a policy that combines life insurance protection with market-based investment exposure.
Investment Options in a VUL Policy
Variable universal life insurance policies typically offer several subaccounts the policyholder can choose to invest in, which may include:
- A fixed-interest option
- Stock subaccounts
- Bond subaccounts
- Money-market subaccounts
Any guarantees associated with these subaccounts are based on the claims-paying ability of the issuing insurance company, not on the performance of the investments themselves.
VUL Cash Value and Policy Loans
As with other forms of permanent life insurance, a variable universal life insurance policy accumulates cash value over time. Policyholders can borrow against a portion of this variable life insurance cash value under generally favorable terms.
Key points about policy loans:
- Interest payments made on policy loans are credited back into the policy’s cash value.
- Loans taken from a policy are generally free of current income taxes, provided certain conditions are met — such as the policy not lapsing or maturing.
- Loans and withdrawals reduce both the policy’s cash value and death benefit.
- Taking a loan increases the possibility that the policy may lapse.
- If the policy lapses, matures, or is surrendered, any outstanding loan balance is treated as a distribution and becomes taxable.
Accessing VUL cash value through borrowing or partial surrenders can reduce the policy’s overall value and benefit, and it may increase the risk of the policy lapsing. If the policy terminates before the insured’s death, this could also result in a tax liability.
How the Death Benefit Works
When the policyholder passes away, their named beneficiaries receive the death benefit from the policy. Depending on how the variable universal life insurance policy is structured, this benefit may or may not be taxable.
Can VUL Premiums Be Self-Funded Through Cash Value?
A variable universal life insurance policy can be structured so that accumulated cash value eventually covers ongoing premium payments. However, this isn’t guaranteed. Additional out-of-pocket contributions may be required if:
- The policy’s dividend decreases, or
- Investment returns underperform expectations
Policyholders should not assume that cash value accumulation alone will permanently sustain the policy without periodic review.
Costs, Charges, and Insurability Factors
Several factors affect the cost and availability of variable universal life insurance, including:
- Age
- Health
- The type and amount of insurance purchased
Additional cost considerations include:
- Life insurance policies carry expenses, including mortality charges and other fees.
- Surrendering a policy prematurely may result in surrender charges and income tax implications.
- Insurability should be assessed before implementing any strategy involving life insurance.
- Any guarantees tied to the policy depend on the financial strength and claims-paying ability of the issuing insurance company.
Tax Considerations for Withdrawals
Withdrawals of earnings from a VUL policy are fully taxable at ordinary income tax rates. Additional considerations include:
- Withdrawals made before age 59½ may be subject to surrender charges and a 10% federal income tax penalty.
- Withdrawals reduce both the death benefit and the overall value of the contract.
Market Risk and Account Value
Because variable universal life insurance is tied to investment performance, the account value will fluctuate with market conditions. At any given time, the account value may be worth more or less than the total amount originally invested in the policy.
Important: Life insurance is not FDIC insured and is not insured by any federal government agency, bank, or savings association.
Before You Invest
Consider the investment objectives, risks, charges, and expenses of a variable universal life insurance policy carefully before investing. Variable life and variable universal life insurance are sold by prospectus only.
Information on fees and expenses can be found in the prospectus or obtained from your financial professional. Read the prospectus carefully before investing or sending money.
Frequently Asked Questions
What is variable universal life insurance?
Variable universal life insurance is permanent life insurance that combines flexible premiums and an adjustable death benefit with policyholder-directed investment subaccounts, such as stock, bond, money-market, or fixed-interest options.
How does variable universal life insurance work?
The policyholder pays flexible premiums, part of which builds cash value invested in subaccounts they choose. The policy remains in force for life as long as it’s adequately funded, and the death benefit is paid to beneficiaries upon the policyholder’s death.
How is a VUL policy different from other permanent life insurance?
Unlike other permanent life insurance products, a variable universal life insurance policy allows the policyholder to direct how premiums are invested, offering potential for higher market-based returns along with greater investment risk.
Can I borrow against my VUL policy’s cash value?
Yes. Policyholders can generally borrow against their variable universal life insurance cash value under favorable terms. However, loans reduce the policy’s cash value and death benefit and may increase the risk of the policy lapsing.
Are withdrawals from a VUL policy taxable?
Withdrawals of earnings are taxed at ordinary income tax rates. Withdrawals made before age 59½ may also incur surrender charges and a 10% federal tax penalty.
