Variable universal life insurance (VUL) is a type of permanent life insurance policy that doesn’t expire and comes with a separate cash value account that earns interest over time. Unlike other permanent life insurance policies, it offers plenty of flexibility: you can increase or decrease both the death benefit and premium payments, and you can choose how the cash value can be invested.
But all that flexibility comes at a cost. VUL policies are significantly more expensive than a term insurance life policy — and they're riskier, too. The death benefit and premiums of VUL can change based on market performance. Because of this, they aren't the best insurance or investment option for most people.
How does variable universal life insurance work?
VUL combines features from universal life and variable life insurance into one policy:
Adjustable death benefit: With a universal life insurance policy, you can increase the death benefit 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.
If your cash value investments underperform, you may need to start paying premiums out of pocket again, which will decrease the amount you can leave to your beneficiaries
Depending on your insurance company, you may have a guaranteed minimum death benefit, but the final amount your beneficiaries will receive when you die 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 as 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 $13.61 million, the death benefit can cover the estate or inheritance tax your beneficiaries have to pay. [1]
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.
Who should consider VUL policies?
Instead of getting a VUL policy, most people are best off getting a term life insurance policy and investing the rest of the money. However, VUL could be a good fit for you if:
You’re already maximizing your traditional retirement options, like your 401(k) and IRA.
You could benefit from having a cash value account.
You feel comfortable choosing stocks and bonds to invest the policy’s cash value in.
You’re comfortable with the variability of changing premium payments and death benefit.
Alternatives to variable universal life insurance
VUL insurance isn’t right for most people due to its high cost and investment risk. Term life, whole life, and even guaranteed universal life insurance are often better options. The right policy for you will depend on your specific financial needs and goals.
Term life insurance
Term life insurance is more affordable than VUL and whole life insurance. If your primary concern is providing a financial safety net for your family during the period of your life when you have the biggest expenses — like a mortgage or young children to raise — term life insurance is likely your best bet.
Term life insurance doesn’t have any complex tax implications or restrictions and frees up money to invest on your own. You can generally get a higher rate of return from traditional investing than from a cash value account.
Whole life insurance
With whole life insurance, you’ll have permanent coverage — which means it won’t expire. 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.
If you’re already maximizing investment contributions elsewhere, whole life insurance may be a good fit for you.
Learn more about the differences between term life and whole life insurance
Guaranteed universal life insurance
If you need a permanent death benefit at a lower cost for estate planning reasons or for lifelong dependents, guaranteed universal life insurance (GUL) may work for you.
VUL comes with fixed premiums, minimal cash value, and a guaranteed death benefit. It’s more affordable and less risky than VUL. Unlike other kinds of universal life insurance, GUL premiums remain the same throughout the life of the policy.
The policy won’t lapse if the cash value isn’t enough to cover the policy expenses, which avoids the risk of poor market performance that other universal life policies face.
Learn more about the differences between whole and indexed universal life insurance (IUL)
