What is variable universal life insurance (VUL)?

Variable universal life insurance (VUL) provides permanent life insurance coverage. It comes with a cash value account that earns interest and can be used to pay your premiums. The cash value of VUL earns interest based on the performance of asset funds of your choosing, such as stocks and bonds. The death benefit can be increased or decreased according to your needs.

If you have exhausted your other investing options, VUL is one way to expand your investment portfolio while financially protecting your beneficiaries. However, a VUL policy is risky because the investing component impacts your premiums and benefit and costs more than a term life policy. Most people are better off keeping their investments separate from their life insurance.

How does variable universal life insurance work?

VUL combines features from universal life and variable life insurance into one policy:

• Adjustable death benefit: Under a universal life policy, you can increase the death benefit (proof that you’re in good health may be required) or decrease it as needed (within limits).

• Flexible premium pricing: Universal life policies allow you to increase or decrease your out-of-pocket premiums by paying them with your cash value instead.

• Cash value investment options: Variable life insurance allows you to choose the funds that determine your cash value interest gains, like an investment account. 

If you need cash, you can borrow against the cash value (including interest) or withdraw all or part of the principal amount. However, if you don’t repay the amount you’ve taken out, it will reduce the death benefit.

That said, if your cash value investments underperform, you may need to start paying premiums out-of-pocket again, which will decrease your death benefit. Depending on your provider, you may have a guaranteed minimum death benefit, but much of the final amount depends on your cash value’s performance.

Pros and cons of variable universal life insurance

A variable universal life insurance policy isn't a good investment for most people, but it can work be part of a financial strategy with the guidance of a licensed professional. 

Pros:

• It’s an additional tax-deferred investment account. People who regularly reach the contribution limits on their retirement accounts might consider VUL.

• VUL can provide a tax-free inheritance. If your estate is valued at more than $12.06 million, [1] the death benefit can cover the estate or inheritance tax your beneficiaries have to pay.

• You can pay your premiums with the cash value. VUL has a higher likelihood of interest gains than permanent insurance plans with less investment risk, which would eventually allow you to cover your premium payments.

Cons:

• It's expensive. Although VUL policies can sometimes be cheaper than whole life insurance, they’re always going to be more expensive than term life insurance. 

• The investment risk is high. Unlike other types of permanent insurance, VUL doesn’t usually come with a guaranteed rate of return and some policies don’t guarantee a minimum death benefit. With few guarantees, you could lose a significant amount of money and leave your loved ones without financial support. [2]

• There are a lot of fees involved. You may have to pay a mortality and expense fee, fees to the mutual funds into which your premiums are invested, and insurance-related fees. All of these eat into your cash value. 

Alternatives to variable universal life insurance

The high cost and unpredictable nature of VUL insurance aren’t right for most people. Term life and whole life insurance are often a better fit, whether you need lifelong coverage or a simple and affordable policy to cover your financial obligations.

Term life insurance

Term life insurance is more affordable than VUL and whole life insurance. Most people don’t need permanent life insurance coverage and term life makes it easy to stay covered only as long as you need to. Unless you’ve exhausted your other investing options, a cash value account is not cost-effective when you could get a higher rate of return from traditional investing. 

Whole life insurance

With whole life insurance, you’re covered for life. Like VUL, premiums are five to 15 times higher than term life insurance premiums. Whole life insurance earns interest at a fixed rate set by your insurance company and you can’t use the cash value to pay premiums. However, the cash value feature is less complex and has lower investment risk than VUL.

Unless you have a high net worth and have maxed out all of your other investment accounts, variable universal life insurance is more complex and expensive than you probably need. You’ll save more money long-term if you purchase a term life insurance policy and invest your savings in a traditional investment account.