One of the main attractions with permanent life insurance, like variable life insurance, is the cash value component attached. The problem with most of these permanent policies is the rate of return is usually low. This is where variable universal life could make a difference.
What is Variable Life Insurance?
Variable universal life insurance is a permanent policy that is part of the universal life family. The difference between variable universal life and a universal life policy is how the cash value component is calculated.
In a variable universal life policy part of your premium goes to pay the COI (cost of insurance), the remaining portion is invested into sub-accounts. These sub-accounts are very similar to mutual fund shares and are tied to the stock market’s performance.
In these sub-accounts there is no guaranteed interest rate or “floor”, if the sub-accounts you choose are in the negative, then your cash value will decrease. With that said, there is no ceiling on what interest you can earn, which is an upside to these policies.
The sub-accounts inside the variable life insurance policy are unique to the policy and cannot be invested in outside of the policy. There are management fees tied to these sub-accounts which can eat up the cash value.
The cash values of the variable life insurance policies grow tax deferred. Withdrawals and loans can also be taken tax free as long as the contract remains in-force. If you surrender the policy any gain will be taxed at ordinary income rates.
What are the advantages of Variable Life Insurance?
- It’s a permanent policy: Variable life insurance is designed to last your lifetime (age 121).
- Cash value grows tax-deferred: The cash value grows tax-deferred which means none of the growth is reported to the IRS. If funded properly can be used to supplement retirement.
- Tax-free withdrawals & loans: Cash value can be pulled out as withdrawals and loans tax-free. You must keep your policy in-force to keep from paying taxes on the gains of the policy. When funded correctly these policies can be very similar to Roth IRA.
- Higher Rate of Return: Being allowed to invest into the sub-accounts which mirror mutual funds, variable universal life policies have a chance for greater rate of return than other permanent life insurance policies.
What are the disadvantages of Variable Universal Life?
- More Expensive: Just like the other permanent life policies, the premium is more expensive than term life insurance. Not only are you a paying a COI (cost of insurance), but you are investing into the sub-accounts as well.
- Premiums are Not Guaranteed: The major problem with these policies is that like the other Universal Life policies the COI (cost of insurance) rises every year. The cash value growth in the variable universal life products is projected to grow and to offset the rising COI. If the investments (sub-accounts) do not perform well or the product was sold on a higher than normal interest rate projection, your premium could be raised. If you refuse to pay this higher premium the carrier could cancel your policy and you would be left with nothing.
- Management Fees can be high: The sub-accounts that are offered with your variable universal life policy all come with there own management fees, very similar to fees associated with Mutual Funds. For some reason these fees associated to the sub-accounts are usually higher than the one’s associated with mutual funds.
- Loss of Cash Value: While there is a chance to make a really good rate of return in a variable universal life policy, there also runs a risk of a down turn in the market. In the variable universal life policy, the cash value component lose money and just like any other investment, a lot of it. It’s very important to review yearly with your agent if you own one of these policies.
Alternatives to Variable Life Insurance
If you want to stay in the permanent life insurance arena, and you like the cash value component of the variable universal life, I would recommend an Indexed Universal Life. These policies allow you some upside interest of the market, without any downside risk of the market. Always make sure to find a policy with a guaranteed premium.
Term life insurance is another alternative to variable universal life. Some recommend investing the difference of premium between term and permanent policies. This concept is call “buy term, invest the difference”. Remember, term does expire and unless your investments have done well you will still probably need life insurance.
life insuranceMy Take
While variable universal life does have some very appealing attributes, I would not recommend a policy like this. While the idea of a lot of cash value growth seems tantalizing, the risk involved when the market doesn’t cooperate far outweighs any cash value accumulation.
Life insurance can be used as a financial tool, but let’s remember, first and foremost it’s used for death protection. Overall, we do not feel Variable Univesal Life is a good investment. There are many other options to choose from, without the risk and high management fees.
If you own one of these types of policies we highly recommend seeing your agent, asking for an in-force illustration, and just make sure it’s still a sound product. If you have any questions or comments, please give us a call.