Using Variable Universal Life Insurance for Supplemental Retirement Savings
Variable Universal Life (VUL) insurance can do more than provide a death benefit — it can also serve as a source of supplemental retirement income. Below is a real-world case study showing how a VUL policy works when qualified retirement plans alone aren’t enough.
The Client
John and Pat, ages 45 and 42, have built successful careers and are already maximizing their employer-sponsored qualified retirement plans. They have two children, ages 12 and 15, and recently moved into their dream home — one that comes with a $500,000 mortgage.
The Need
Before buying their new home, John and Pat had enough life insurance to meet their needs. Now they’re concerned about two things:
- Leaving behind an unpaid $500,000 mortgage if either of them were to pass away
- Having enough retirement savings to generate adequate income later in life
The Problem
John and Pat have already maxed out their 401(k) and other qualified plan contributions, and they aren’t eligible for Roth IRAs. They’re looking for a strategy that addresses both protection and supplemental retirement savings at the same time.
Comparing Retirement Savings Options
Different savings vehicles come with different rules around contribution limits, tax-deferred growth, and taxation on distribution. Here’s how several common options compare, including variable universal life insurance:
| Account Type | Contribution Limits | Tax-Deferred Accumulation | Taxes on Distribution | Income Tax-Free Death Benefit |
|---|---|---|---|---|
| Traditional IRA | Yes | Yes | Yes | No |
| Roth IRA | Yes | Yes | No | No |
| Qualified Plan | Yes | Yes | Yes | No |
| Certificate of Deposit | No | No | Yes | No |
| Mutual Funds | No | No | Yes¹ | No |
| Municipal Bond Funds | No | Yes | Sometimes² | No |
| Annuity | No | Yes | Yes | No |
| Variable Life Insurance | No | Yes | No | Yes |
The Solution: A VUL Policy for Each Spouse
John and Pat will each purchase a variable universal life insurance policy with an initial $500,000 death benefit, using the increasing death benefit option.
How the Policies Are Funded
- Each policy is funded annually using the maximum non-MEC premium (a policy that isn’t classified as a Modified Endowment Contract).
- Contributions continue until age 65.
- At age 65, the death benefit levels off, and each policy can begin generating tax-free retirement income through age 90.
- The policy stays in force through age 100. Provided there is a positive cash value at that point, the death benefit remains in force with no further expense or mortality deductions until it’s paid as a death claim.
A survivorship VUL policy covering both spouses under a single policy is also an option, depending on their needs, instead of two individual policies.
Single Life VUL Overview
| John | Pat | John & Pat (Survivorship) | |
|---|---|---|---|
| Annual Premium | $25,700 | $20,200 | $16,700 |
| Cash Value at Age 65 | $842,200 | $865,600 | $563,100 (year 20) |
| Internal Rate of Return on Cash Value at Age 65⁵ | 4.49% | 4.87% | 4.76% (year 20) |
| Annual Tax-Free Income to Age 90⁶ | $62,100 | $64,700 | $40,900 to year 48 |
| Death Benefit at Standard Mortality | $716,100 | $542,000 | $176,400 (standard joint mortality) |
| IRR on Death Benefit at Standard Mortality | 5.31% | 5.51% | 5.59% |
*The data shown is taken from an illustration. It assumes a hypothetical 7.00% rate of return and is not a representation of expected future results. Unless otherwise indicated, these values are not guaranteed.
John’s VUL Scenario in Plain Terms
If John funds his policy for 20 years (to age 65) at $25,700 annually, his total outlay is $514,000.
At that point, he could withdraw $62,100 per year, income tax-free, through age 90 — a potential total of $1,552,500 in tax-free living benefits.
At his death, following the end of his income withdrawals, his beneficiary would receive an additional tax-free death benefit, ranging from roughly $20,000 to $80,000 depending on timing.
In this scenario, every $1 of after-tax premium could generate over $3 in income tax-free living benefits.
An Alternative Scenario
Using standard actuarial life expectancy, John might pass away around year 30 of the plan. In that case:
- He would have received 10 years of tax-free income, totaling $621,000
- His beneficiary would receive a projected tax-free death benefit of approximately $716,000
- Combined tax-free plan benefits: $1,337,000
In this scenario, every $1 of after-tax premium generates about $2.60 in income tax-free benefits.
Combined Plan Benefits for John and Pat
When both spouses’ VUL policies are combined, the numbers look like this:
- Annual premium: $45,900
- Total premium funding to each age 65: $978,600
- Annual tax-free income: $126,800
- Total tax-free income to respective mortality ages: $1,656,200
- Total tax-free death benefit at respective standard mortality ages: $1,258,000
- Total plan tax-free benefits: $2,914,200
As a combined summary, every $1 of after-tax premium generates about $2.98 in income tax-free benefits.
Key Benefits of This VUL Strategy
- Each spouse holds an individual policy tailored to their own financial needs and funded according to their own resources.
- At retirement, income withdrawals from the VUL policies can be adjusted year to year — more in some years, less in others, as needed.
- A new source of tax-deferred savings can convert into potentially tax-free retirement income.³
What Happens When One Spouse Passes Away
If one spouse passes away, the surviving spouse may be able to:
- Use the income tax-free death benefit to supplement their own living expenses, or
- Repay any outstanding loan on their own policy, which could:
- Increase the supplemental retirement income they’re drawing from their own policy, or
- Extend the length of time they can receive distributions from their policy
Frequently Asked Questions
What is Variable Universal Life (VUL) insurance?
VUL is a type of permanent life insurance that combines a death benefit with a cash value component that grows on a tax-deferred basis. Policyholders can often access that cash value through tax-free loans or withdrawals, subject to policy rules.
How does VUL provide supplemental retirement income?
Once a VUL policy is sufficiently funded, policyholders may be able to withdraw income tax-free income from the policy’s cash value during retirement, in addition to the policy’s death benefit.
What is a non-MEC life insurance policy?
A non-MEC (non-Modified Endowment Contract) policy is structured so that withdrawals and loans can be taken without triggering the less favorable tax treatment that applies to Modified Endowment Contracts under IRC §7702A.
What is survivorship VUL?
Survivorship VUL is a single policy that covers two people, typically spouses, rather than each person holding an individual policy. It may be used as an alternative to two single-life VUL policies depending on a couple’s needs.
Are VUL policy loans taxable?
Policy loans are generally not taxable, provided the policy remains in force until the insured passes away. However, withdrawals and loans can reduce the policy’s cash value and death benefit.
Is a VUL policy right for everyone?
Not necessarily. A VUL strategy works best for individuals who have already maximized other qualified retirement plan options and are looking for additional tax-deferred savings and tax-free income potential. It’s important to determine insurability and consult a financial or tax professional before implementing this type of strategy.
Talk to a Financial Professional in Florida
If you’ve maxed out your qualified retirement plans and are exploring additional ways to save, a Variable Universal Life insurance strategy may be worth considering as part of your broader financial plan. The Art and Science of Successful Planning, based in Fort Myers, Florida, works with clients throughout Southwest Florida to evaluate whether a VUL policy fits their retirement and legacy planning goals.
¹ Mutual funds may be subject to income tax and/or capital gains taxation. Consult your tax advisor for more information.
² Not all municipal bonds are exempt from federal and state income tax. Some bonds may be subject to capital gains tax upon sale. Consult your tax advisor for more information.
³ For a life insurance policy that is not a Modified Endowment Contract as defined in IRC §7702A: withdrawals in the first 15 policy years may be taxable under IRC §7702(l)(7)(B); after 15 years, withdrawals up to the policy’s tax basis are not taxable; and policy loans are not taxable provided the policy remains in force until the insured’s death. Withdrawals and policy loans may reduce policy values and death benefits.
All dollar amounts are rounded to the nearest $100. The internal rate of return shown is the pre-tax rate of return. This material conforms to existing tax laws as of the time of publication.
The Art and Science of Successful Planning does not provide tax or legal advice. The strategies discussed may not be suitable for everyone. Individuals should consult their own tax advisor and legal counsel before implementing any strategy discussed here.
