Most legal and financial products are designed to meet one specific need, but where does that leave you if you need more than that?
Equities are typically purchased by those who desire to grow their investment assets. Fixed-income securities are purchased by investors who have current income as their primary investment goal. Annuities may be attractive to individuals who wish to generate tax-deferred capital appreciation, or to consumers who need a vehicle from which to take asset distributions. Wills and trusts are often drafted to aid in the settlement of estates. And finally, life insurance is generally purchased by those who have a need to protect their assets or for those whose premature death - i.e., a primary wage earner - would result in loved ones enduring financial hardship.
However, atypical to the products noted above, variable universal life (VUL) policies may enable policy owners to enjoy not just one, but multiple, benefits. Rather than simply taking advantage of the asset-protection features of life insurance, policy owners can gain from the tax-deferred capital appreciation and estate-planning aspects of the policy. Read on to learn the many benefits of VUL policies.
All-In-One Features of VUL
Variable universal life insurance has all of the same standard features as other cash-value life insurance policies. It has a policy owner, insured person, death benefit, beneficiary, premium, cash value, loan and withdrawal provisions, and more.
A feature that makes VUL policies distinct from other cash-value life insurance is the sub-accounts they contain. Sub-accounts are investment vehicles that enable policy owners to direct a portion of their premium payments.
They are very similar to mutual funds in that they are overseen by an investment manager that determines the equity and/or fixed-income securities in which to invest. The ability to direct funds to investment managers that select equities gives policy owners the opportunity to generate tax-deferred capital appreciation via participation in the equity markets. Historically, investing in equities has been one of the most effective ways for individuals to accumulate wealth over long periods of time.
The sub-accounts found in VUL policies are a crucially important feature for anyone considering the purchase of a VUL because the existence of the policy is partially depends on the performance of the sub-accounts. The policy owner may have to contribute more money to the policy than he or she is financially able to if the sub-accounts under-perform. Also, the policy may lapse if additional contributions cannot be made. (To find out more about select premiums, contributions and distributions, see Understand Your Insurance Contract and Exploring Advanced Insurance Contract Fundamentals.)
Risk Reduction Technique
Fortunately, a technique can be employed that serves to mitigate some of the risk associated with the possibility that the sub-accounts under-perform. The technique is called "overfunding".
Paying More to Get More
Overfunding involves contributing more money to the policy than what is required by the contract. That is, you put money in the policy above and beyond the required premium.
This additional contribution creates an added layer of protection for policy owners. The added layer functions as a cushion in the event that the sub-accounts under-perform. Because contributions above and beyond the premium are already being made, additional payments to support the policy in the event of a downturn in the stock market are less likely to be needed.
Note: Care has to be taken that the policy does not become a modified endowment contract. Consult your insurance, legal or other trusted advisor for guidance.
Estate Planning and Preservation
While some are drawn to the asset protection or tax-deferred wealth accumulation features of overfunded VULs, others are attracted to the estate-planning opportunities that the policy affords. Insured persons can use the naming of beneficiaries - rather than simply relying on wills and/or trusts - to direct the distribution of estate assets. Like other cash-value insurance policies, VULs pay out a tax-free death benefit when the insured dies. (To learn more about estate planning, see Getting Started On Your Estate Plan, The Importance Of Estate And Contingency Planning and Three Documents You Shouldn't Do Without.)
This tax advantage associated with the distribution of life insurance proceeds is an effective estate planning tool for many. Policy beneficiaries often use the proceeds to pay estate taxes that are owed on a decedent's estate. While the Economic Growth and Tax Relief Reconciliation Act of 2001 created more favorable terms for those subject to estate tax through 2010, uncertainty regarding the sunset provision that is scheduled to take place in 2011 is reason for those facing an estate tax liability to consider the estate preservation feature of VUL insurance. (To find out more about beneficiary designations, read Update Your Beneficiaries, Problematic Beneficiary Designations - Part 1 and Part 2.)
The Multipurpose Tool
Overfunded VUL insurance may be one of the most versatile financial products in the marketplace. The product contains the tax-deferred asset accumulation potential of equities, the asset protection of life insurance and the estate-planning features of wills and trusts. It may appeal to those that prefer an all-in-one financial solution rather than disjointed plans that require the coordination of various moving parts.
Typically, the product works well for individuals who have an insurance need, are fully funding contributions to tax-advantaged plans (i.e., 401(k)s or IRAs), have a long time horizon (20+ years), a preference for tax-deferred growth of assets, object to the tax consequences that are generated in taxable accounts (short- and long-term capital gains, capital gains distributions, taxes on dividend and interest income, etc.), expect estate taxes to be due when they die and have a desire to create a legacy. As you can see, VUL policies off a number of potential benefits that make them an attractive option for many. This a product that may be worth discussing with your trusted advisor.
To read more on this subject, see Buying Life Insurance: Term Versus Permanent and What is the difference between term and universal life insurance?
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