Variable Life Insurance vs. Variable Universal Life (VUL) Insurance: An Overview

For investors that love to watch the market, variable life insurance products are interesting. These products allow for a portion of the premium to be allocated to the insurance company's investment fund, allowing tax-free profits to be generated for beneficiaries.

Investors looking for life insurance coverage have a number of options, from term to whole life, and many things in between. Life changes mean that insurance needs change too, where it’s important to re-evaluate your financial plan after major life events, such as marriage or a home purchase.

Key Takeaways

  • A variable life insurance allows most of the premiums to be invested in an investment account. A variable universal life insurance policy combines the benefits of a variable policy with a universal—or whole life—policy.
  • One of the key risks of both types of policies is the fluctuation in cash value and death benefits due to the performance of investments.
  • A key benefit is that both are allowed to grow on a tax-deferred basis,
  • Both are governed by securities law and require a prospectus.

Variable Life Insurance

In a variable life insurance policy, the bulk of the premium is invested in one or more separate investment accounts, with the opportunity to select from a wide range of investment options—fixed-income, stocks, mutual funds, bonds, and money market funds. What's more, the interest earned on the accounts increases with the account's cash value. Risk tolerance and investment objectives determine the amount of risk to be undertaken.

Normally, insurers have their own professional investment managers supervising the investments. Therefore, the overall asset performance of the investment is generally the main topic of concern.

Variable Universal Life (VUL) Insurance

Variable universal life (VUL) insurance, as the name suggests, is a policy that combines variable and universal life insurance (i.e., flexible variable life insurance). This is one of the more popular insurance policies because it gives its policyholders the option to invest as well as alter the insurance coverage with ease.

As with universal life insurance, a policyholder has the ability to decide the amount and the frequency of premium payment, although within specific limits. You may also make a lump sum payment within certain limits, or use your accrued cash value toward premium payments.

Key Differences

Risks

A variable life policy is quite risky because the cash value and death benefits can fluctuate in accordance with the performance of the investment portfolio. Therefore, if the underlying investments perform well, the death benefit and cash value may increase accordingly. If the investments perform worse than expected, the death benefit and cash value may decrease.

A variable life insurance policy does offer a guaranteed death benefit, which will not fall below a minimum amount even if the invested assets devalue significantly. This guaranteed death benefit requires higher premiums, however. The funding of the death benefit will be done by applying an assumed rate of interest, usually around 4%. If the fund performance exceeds or declines beyond this assumed rate of interest, the death benefit will go up or down accordingly.

VUL policies allow the policyholder to increase and decrease the death benefit as they please. An increase in the death benefit calls for evidence that of good health, while a decrease in the death benefit may have surrender charges. There are two options of death benefit: fixed death benefit and variable death benefit. The variable death benefit is equal to the cash value at the time of death, plus the face value of the insurance.

Unlike universal life insurance, this policy offers the freedom to invest in a preferred investment portfolio. The policyholder can be a conservative or aggressive investor. The investment options vary among insurers, but almost all VUL policies consist of investment in stocks, bonds, money market securities, mutual funds, and even the most conservative option of guaranteed fixed interest. Thus, there is a possibility that the underlying assets provide negative returns.

Taxes

As with permanent life policies, the cash value of a variable life insurance policy grows on a tax-deferred basis. Many insurers allow premium payments to be paid via the accumulated cash value, which means a reduction in premium payment. However, if the investments perform poorly, less money will be accessible from the cash value, and more money will have to be paid in order to keep the policy in force.

Meanwhile, because it is a permanent life policy, VUL provides tax-deferred cash value and loan withdrawals, within certain limits, against the cash value. Normally, policy loans are tax-free, but you need to confirm this with your insurance advisor, as the tax implications may differ from one state to another.

Governing Bodies

Because a variable life policy deals with security investment risks, it is considered a securities contract and is governed by prevailing securities law. It is obligatory to read the prospectus carefully before investing in a variable life insurance policy.

Like variable insurance, due to their inherent securities risk, VUL policies must be sold with a prospectus and are governed by securities laws. You must carefully read the prospectus before buying a VUL policy.

The Bottom Line

An individual’s insurance coverage needs may change over time, and variable life insurance products do a good job of factoring in these potential changes. Variable life, as well as VUL policies, form a perfect hedge against inflation. For some, control over investments through variable life offers a desired edge, while others may prefer VUL for its high level of flexibility and the policyholder's openmindedness toward market fluctuations.