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What is 'Variable Universal Life Insurance - VUL'

Variable universal life insurance (VUL) is a form of cash-value life insurance that offers both a death benefit and an investment feature. The premium amount for variable universal life insurance (VUL) is flexible and may be changed by the consumer as needed, though these changes can result in a change in the coverage amount.

BREAKING DOWN 'Variable Universal Life Insurance - VUL'

The investment feature usually includes sub-accounts, which function very similarly to mutual funds and can provide exposure to stocks and bonds. This exposure offers the possibility of an increased rate of return over a normal universal life or permanent insurance policy.

While variable universal life insurance offers increased flexibility and growth potential over a traditional cash-value whole life insurance policy, investors should be sure to compare this type of policy against a "buy term and invest the rest" strategy. They should pay particular attention to the management fees of the variable investment options, as well as to whether an individual even needs life insurance coverage beyond a specific point in the future.

How Variable Universal Life Insurance Works

Like universal life insurance, variable universal life insurance combines a separate savings component with a separate death benefit component, allowing for greater flexibility in managing the policy. Premium payments are paid into the savings component, which, for variable universal life insurance, consist of separately managed accounts also referred to as sub-accounts. Each year, the life insurer takes what it needs to cover mortality and administrative costs. The rest remains in the separate accounts.

Transfer of Investment Risk

In a whole life policy, the life insurer assumes the investment risk by guaranteeing minimum cash value growth. By separating the savings component and the death benefit component, the life insurer transfers the investment risk to the insured, providing the opportunity to earn a higher rate of return. The insured assumes the risk that the separate accounts may generate negative returns, which reduces the cash value available to pay expenses. This might require that the insured make additional premium payments. This transfer of risk allows the insurer to charge a lower premium than would be charged on a whole life policy.

Sub-Accounts

The separate accounts are structured similar to a family of mutual funds, with an array of stock and bond accounts along with a money market option. Policyholders are allowed to transfer between the accounts up to a certain number of times per year, typically four. In addition to the mortality and administration fees paid by the policyholder each year, the separate accounts deduct management fees that can range from 0.05% to 2%.

Cash Value

The cash value inside a variable universal life policy is allowed to grow tax deferred. Policyholders can access their cash value by taking a withdrawal or by borrowing funds. However, if the cash value falls below a certain level, additional premium payments must be made to prevent the policy from lapsing.

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