What Type of Life Insurance Allows You to Choose Investments?

Life insurance provides a death benefit to beneficiaries upon the policyholder’s passing. Not all life insurance policies offer the ability to choose underlying investments. This article clarifies which specific policy type allows investment choice and how it functions within a comprehensive financial strategy.

Overview of Life Insurance Policy Types

Life insurance policies fall into two categories: term life and permanent life. Term life insurance provides coverage for a specific period, such as 10, 20, or 30 years. It does not accumulate cash value, so term life policies offer no investment choices.

Permanent life insurance provides coverage for the policyholder’s entire life and includes a cash value component that grows over time. Whole life insurance, a type of permanent policy, features a guaranteed cash value that accumulates at a fixed interest rate set by the insurer. Policyholders do not make investment decisions; the insurer manages the underlying assets.

Universal life (UL) insurance is another permanent coverage, offering more flexibility than whole life in premiums and death benefits. A UL policy’s cash value grows based on an interest rate set by the insurer, often with a minimum guaranteed rate. While UL offers flexibility and accumulates cash value, the policyholder does not select the investments; the insurer maintains control.

Variable Universal Life Policies

Variable Universal Life (VUL) insurance is the specific policy type that allows policyholder investment choice. It is a permanent life insurance policy combining a death benefit with a cash value component, allowing investment in various sub-accounts. This feature distinguishes VUL from other permanent life insurance options, where the insurance company manages investment decisions.

A VUL policy has two main parts: a death benefit and a cash value component. The cash value growth is directly tied to the performance of the policyholder’s chosen investments. Unlike the guaranteed or insurer-determined rates of whole life and traditional universal life policies, VUL cash value fluctuates with market performance, carrying the risk of investment losses.

VUL policies offer flexibility in premium payments and death benefits, similar to other universal life policies. Policyholders can adjust payments or skip them if the cash value covers policy costs. The ability to direct cash value into market-based investments primarily sets VUL apart.

Investment Options and Management in VUL

VUL policies allow policyholders to choose how their cash value is invested by allocating funds among various “sub-accounts.” These sub-accounts function similarly to mutual funds, offering exposure to different asset classes. Examples include stock, bond, and money market funds. Some policies offer sub-accounts mirroring market indexes or with aggressive or conservative strategies.

The performance of these chosen sub-accounts directly impacts the policy’s cash value. If investments perform well, the cash value grows; if they perform poorly, it decreases. This direct link to market performance means policyholders assume the investment risk within a VUL policy.

Policyholders actively manage these investments, including transferring funds between sub-accounts. Some policies may restrict free transfers annually, or charge fees for additional ones. This ongoing management requires policyholders to monitor investments and adjust allocations as market conditions or personal financial goals change. Cash value growth within a VUL policy is generally tax-deferred, meaning taxes are not typically owed on investment gains until they are withdrawn.

Key Considerations for VUL Policyholders

Fees and charges associated with VUL policies are important for potential policyholders. These policies involve various costs, including mortality and expense charges, administrative fees, and investment management fees within sub-accounts. These fees can significantly impact cash value accumulation and may be higher compared to other life insurance types. Surrender charges may also apply if the policy is terminated within a certain period, often declining over the first 10 to 15 years.

Investment risk is a significant consideration for VUL policyholders. Unlike policies with guaranteed cash value growth, VUL cash values are subject to market fluctuations. Poor investment performance can decrease cash value, potentially requiring higher premium payments to maintain the death benefit or risking policy lapse. Policyholders bear this investment risk, as the insurance company does not guarantee returns on sub-accounts.

VUL policies are suitable for individuals comfortable with investment risk and a long-term investment horizon. They are often considered by those who have maximized contributions to other tax-advantaged retirement accounts and seek additional avenues for tax-deferred growth. Active monitoring and management of the policy’s investments are required to optimize performance. Given the complexity and inherent risks, consulting a qualified financial advisor is advisable to determine if a VUL policy aligns with individual financial goals, risk tolerance, and overall financial plan.