Is Variable Universal Life Insurance a Good Investment?

Variable Universal Life (VUL) insurance is a permanent life insurance policy that integrates a death benefit with a cash value component tied to investment performance. This policy remains in force for the insured’s entire life, provided sufficient premiums are paid. This article clarifies VUL policies to help readers assess if one aligns with their financial situation and objectives.

Components of Variable Universal Life Insurance

A VUL policy combines a life insurance death benefit and an investment-linked savings component. The death benefit provides a financial payout to beneficiaries upon the insured’s passing, generally income-tax-free. The policy offers lifelong protection, contingent on the cash value covering ongoing policy costs.

The cash value account is the distinctive investment-linked component. Premiums are allocated among the death benefit cost, policy expenses, and the cash value. What remains after deductions goes into the cash value. Policyholders have flexibility in making premium payments, adjusting the amount and frequency within limits, a feature borrowed from universal life insurance.

This flexibility allows policyholders to pay more to increase cash value, or pay less, or even skip payments, if the cash value covers policy costs. However, consistently paying only minimum premiums could necessitate higher payments later to maintain coverage. The death benefit can also be increased or decreased to suit changing needs, though increases may require additional underwriting.

How VUL’s Cash Value Grows

The cash value grows through investments in separate accounts, often called sub-accounts. These sub-accounts operate like mutual funds, offering investment options such as stock, bond, and money market funds. Policyholders choose how their cash value is allocated among these sub-accounts, aligning investments with their risk tolerance and financial objectives.

Cash value growth links directly to the performance of these sub-accounts. If investments perform well, the cash value can increase. Conversely, the cash value is subject to market fluctuations and can decrease if investments perform poorly, introducing market risk. This exposure to market risk defines VUL policies, distinguishing them from policies with guaranteed returns.

The cash value within a VUL policy offers tax-deferred growth. Earnings on investments in the sub-accounts are not subject to current income tax, allowing money to compound without annual tax implications, similar to certain retirement accounts. Taxes are deferred until funds are withdrawn or loaned from the policy. Policyholders can access their cash value through policy loans or withdrawals.

Accessing cash value through loans means borrowing against the policy’s value. These loans are tax-free as long as the policy remains in force and is not classified as a Modified Endowment Contract (MEC). Unpaid loans reduce the death benefit paid to beneficiaries. Withdrawals directly reduce the cash value and death benefit, and may be taxable if the amount withdrawn exceeds premiums paid into the policy.

Costs and Charges of VUL Policies

Variable Universal Life policies come with a range of fees and charges that can significantly impact the growth of the cash value. One primary category includes mortality and expense (M&E) charges, which cover the cost of providing the death benefit and managing the policy’s investment component. These charges are typically deducted from the cash value or premiums, and the cost of insurance (COI) component, specifically, tends to increase with the insured’s age.

In addition to M&E charges, VUL policies incur various administrative fees for policy maintenance and record-keeping. These can include policy administration fees, transaction fees for transfers between sub-accounts, and fees for certain policy changes. Such fees are regularly deducted from the cash value, reducing the amount available for investment growth.

The underlying investment sub-accounts themselves also carry investment management fees, similar to the expense ratios found in mutual funds. These investment management fees compensate the fund managers for their oversight of the sub-account portfolios. They typically range from about 0.05% to 2% of the assets managed within those sub-accounts annually. Another important cost is the surrender charge, which is a fee incurred if the policy is terminated or surrendered early, usually within the first 10 to 15 years of the policy’s existence.

Surrender charges can be substantial, often representing a percentage of the cash value or premiums paid, and are designed to recoup the insurer’s upfront costs. Policyholders may also opt for additional riders, which are enhancements or supplementary benefits added to the policy, such as a waiver of premium or a long-term care rider. Each of these riders typically comes with its own associated cost, deducted from the cash value or premiums. All these various fees and charges are systematically deducted from the cash value, meaning they directly reduce the amount available for investment and can significantly erode the policy’s growth potential, especially in early years.

Assessing VUL for Your Financial Goals

Evaluating Variable Universal Life insurance as an investment requires a comprehensive understanding of its structure, growth potential, and associated costs in relation to individual financial goals. VUL policies may be suitable for certain high-income individuals who have already maximized contributions to other tax-advantaged retirement vehicles, such as 401(k)s and Individual Retirement Accounts (IRAs). The tax-deferred growth of the cash value can offer an additional avenue for wealth accumulation. These policies can also serve long-term estate planning objectives, as the death benefit is typically paid out income-tax-free to beneficiaries.

However, VUL policies are generally not ideal for short-term savings or individuals seeking highly liquid investments due to their long-term nature and potential surrender charges for early termination. The high initial fees and the market risk make them less suitable for those with low risk tolerance or those who may need to access their funds in the near future. The performance of the cash value is not guaranteed, and poor market performance could lead to a decline in value, potentially requiring higher premium payments to keep the policy from lapsing.

When comparing VUL to alternative investment vehicles, it is important to consider liquidity, control, and cost-efficiency. Traditional investment accounts like brokerage accounts, 401(k)s, and IRAs often provide greater investment control and generally have lower fee structures. While VUL offers tax-deferred growth and potential tax-free loans, the extensive internal costs can significantly offset these advantages, particularly if investment returns are modest. For many, separating insurance needs from investment goals, by purchasing term life insurance and investing separately in a diversified portfolio, may offer greater transparency, flexibility, and potentially higher net returns.

The dual purpose of VUL, combining life insurance with an investment component, presents a trade-off. While it offers the convenience of a single product, the complexity and layered fee structure can make it less efficient for pure investment accumulation compared to direct market investments. Policyholders must be comfortable with the responsibility of actively managing their sub-account allocations and monitoring policy performance. A VUL policy is a long-term commitment, and its success as a financial tool largely depends on sustained premium payments, favorable market conditions, and diligent management over many years.