Variable Universal Life (VUL)

What Is It?

Permanent (Cash Value) Life Insurance with Maximum Flexibility

The most versatile kind of permanent (cash value) life insurance is variable universal life (VUL). VUL combines the flexibility of premium payments, options for death benefits, and withdrawal capabilities of universal life (UL) plans with the various investment accounts of variable life (VL) policies. By combining the attributes of these two policy kinds, you can create a policy that will work for you now and in the future. The Securities and Exchange Commission (SEC) must receive registration information for the policy due to the nature of the investments, which are typically referred to as subaccounts. Additionally, agents who offer this kind of policy need to hold a license to sell securities. There can also be additional state regulations. Other names for VUL include equity-based whole life, modified premium variable life, flexible premium variable life, and universal life II. The link between VUL, UL, and VL is displayed in the following table:

*While the success of the insurer's overall portfolio affects current interest, changes in the market have no effect on the value of the accumulated cash.

**The insurance company sets a minimum rate of return for funds invested in the general fund. Money invested elsewhere is influenced by the state of the market. The insurer's capacity to pay claims affects guarantees.

Caution: Keep in mind that registering a VUL policy with the SEC does not mean that the policy is endorsed or approved by the SEC.

Caution: Prospectuses are used to sell Variable Life (OR Variable Universal Life). Before making an investment, please carefully examine the investment objectives, risks, charges, expenditures, and your requirement for death-benefit coverage. Your financial professional can provide you with the prospectus, which includes these and other details regarding the variable life (or variable universal life) policy and the underlying investment alternatives. Before choosing to invest, make sure you properly read the prospectus.

When Can It Be Used?

You Have a Need for Insurance And Want Maximum Policy Flexibility

A variable universal life (VUL) policy can be a good fit for you if you require life insurance and want flexibility and control over your coverage. With this kind of coverage, you can create a policy that gives you flexibility in selecting subaccounts and adjusting the premium and death benefit amounts.

You Are Willing to Assume the Risks Associated With Investing

Selecting subaccounts entails taking on the same dangers as any other investment. Unlike other policy types (like whole life or universal life), your premiums with a VUL policy can be invested more aggressively. You might therefore be able to get larger returns. Your cash value and death benefit could rise as a result of positive returns, but they could also fall as a result of market circumstances pertaining to the subaccounts you have chosen.

You Have a Long-Term Cash Accumulation Need (15 Years)

You might be saving money for a particular future need—like funding your child's college education or augmenting your retirement—as part of your overall financial strategy. If you pass away too soon, a VUL policy can be a valuable tool for financial planning since it pays a death benefit to your beneficiary. Furthermore, the policy has cash values that you can access for purposes related to finances at any moment during your lifetime. Generally, you want to allow yourself about 15 years before you need the money for your particular purpose so that cash values have time to build up to a significant amount (though this is not guaranteed).

Caution: Under the modified endowment contract (MEC) rules, there could be tax consequences (in addition to any surrender charges) as a result of significant overfunding of the policy and/or material changes in benefits during the early years of the policy. Consult your tax advisor.

Strengths

Provides Benefits Common to All Cash Value Insurance

Like all other permanent cash value policies, a variable universal life (VUL) policy contains the following features:

1. Cash value grows tax deferred

2. Cash value can be borrowed against (though borrowing may reduce the policy's death benefit)

Offers Maximum Flexibility

VUL policies are the most flexible of the existing life insurance policy types. This type of policy provides you with the ability to choose and make changes to your policy and subaccounts. VUL combines what have been described as the best features from variable life and universal life.

You Choose Your Subaccounts

You can select the subaccounts you want to use with a VUL policy. Generally speaking, you have the option to select many subaccount types and transfer funds between them.

Caution: There may be a limit on how many times you can move your money between subaccounts in a given time period and/or fees if you exceed a certain number. Check your policy.

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Wide Variety of Investment Options Available (Including Insurer's General Fund)

VUL policies offer a number of different investment options. As with variable life policies, the investment options may include foreign stock and bond portfolios, portfolios in specialized industry or economic sectors, and various bond and government portfolios. Large insurance companies often manage their own accounts, while smaller insurers may use outside investment firms that specialize in money management.

Generally speaking, you are tax-free to invest in multiple investment portfolios and to transfer cash between them as needed. Your investments are kept apart from the general fund of the insurance company in other accounts. These separate accounts might be shielded from creditor claims in the case of insurer insolvency, save from claims that are specifically related to the separate account and the associated insurance policies.

A lot of VUL plans also provide you the opportunity to invest in the general fund of the insurance business in addition to the possibilities for separate subaccounts. The insurance company guarantees a minimum rate of return on investments made into the general fund, which is subject to periodic adjustments. You will still get the guaranteed minimum rate of interest on any amount of your cash value put in the general fund, even in the event that the insurance company's investments underperform.

Tip: If you want to invest solely in the insurance company's general fund, check out universal life insurance.

Caution: Guarantees are subject to the claims-paying ability of the insurer.

Provides Wide Discretion in Choosing Timing and Amount of Premium Payments--No Advance Notice Needed

Similar to universal life, VUL offers totally adjustable premiums. If the cash worth of the insurance is sufficient to pay for policy expenditure charges, you can usually omit, reduce, or even increase premiums after the first policy year. You can alter how often or how much you pay your premiums without informing the insurer in advance. The majority of insurers recommend a target premium level to maintain the policy's viability, and some may set a minimum premium amount (in certain situations as low as $25) if you decide to pay the premium (i.e., no $5 weekly payments).

Tip: Large premium payments in the policy's early years, or at other times when cash is available, can reduce or eliminate the need for premium payments at other times. There may be maximum limits imposed by law to prevent excessive policy funding.

Caution: If your cash accumulation value isn't sufficient to cover the current expense and mortality charges, you may be required to make an additional premium payment in order to prevent a policy lapse.

Offers Choice of Two Death Benefit Options

Similar to universal life, VUL gives you a choice between two methods for receiving death benefits: Option A (sometimes referred to as option I):This plan, like regular whole life, has a fixed death benefit. Option A's death benefit consists of both the cash value and a pure insurance component. To maintain a constant death benefit, the amount of pure insurance is decreased as the cash value increases. The cash value may increase to the point where it meets or surpasses the death benefit, at which point it will no longer be considered a life insurance contract. The death benefit should be raised to prevent this.

Option B (also known as option II): In this option, your cash value increases along with the death benefit. In Option B, the cash value of the term insurance rider is equivalent to that of a whole life policy, operating identically. The policy cash value plus a predetermined amount of pure insurance constitutes the death benefit at any given time. Generally speaking, as long as you follow the rules, you are free to switch between options.

You Can Change the Amount of Your Death Benefit

By giving you the flexibility to change the death benefit of your policy, a variable-unit life insurance policy (VUL) can adjust to your evolving demands and situation. You can adjust your coverage to suit your changing needs as an insurance consumer without having to purchase new insurance or cancel an old one. A medical examination to verify insurability may be necessary for increases in the policy's death benefit.

Tip: Depending on your cash value accumulation, you may be able to increase your death benefit without an increase in premiums. Check with your insurance agent.

Caution: Decreases to your death benefit could have tax consequences. See Tradeoffs. Consult your financial advisor.

Fees Are Fully Disclosed--You Can See What You Pay For

You will be responsible for costs and expenses associated with purchasing any kind of life insurance coverage. A VUL insurance (as well as some other varieties, such as universal life) differs primarily from other policy types in that the fees and charges are fully disclosed and unbundled, making it impossible to identify individual items. The charges derived from cash value and premiums are both indicated. This can help in the process of comparing the fees that various policies charge, yet fees and costs shouldn't be your main consideration when selecting an insurance.

Partial Withdrawals of Cash Value May Be Allowed

If you have a variable universal life policy (VUL), you might be able to take out a portion of its cash value by submitting a formal request to the insurance company for a partial policy surrender (also known as a withdrawal of surplus cash value). There can be minimum and maximum amounts that can be withdrawn, depending on your particular policy.

Caution: Surrender charges are included in many variable universal life insurance policies to stop the cash value from being used as a checking account and to pay the insurance company back for expenses incurred during the policy's early years. There could be surrender fees for ten or fifteen years. Examine your policies.

Caution: Withdrawals may reduce your policy's death benefit.

Tradeoffs

Death Benefit Generally Not Guaranteed

Generally, the death benefit with a variable universal life (VUL) policy is neither fixed nor guaranteed and can increase or decrease depending on both the level of cash value in the policy and the death benefit option chosen. With the variable death benefit option (option B), your cash value is added to the specified death benefit amount and can fluctuate daily based on the investment performance of the underlying subaccounts.

Some policies do offer a death benefit guarantee for your peace of mind (though this guarantee will be subject to the claims-paying ability of the insurer). Ask your agent if his or her policy offers this benefit.

Investments Outside Insurer's General Fund Not Guaranteed

The insurance provider does not guarantee the minimum cash value balance or interest rate when you select a VUL policy and invest in subaccounts other than the general fund. With this kind of coverage, you invest your money and bear all the risk and liability that goes along with it, exactly like you would have if you had done it yourself. Your cash values and death benefit could increase, as is very feasible, but they could also decrease depending on the state of the market.

Caution: Theoretically, your policy cash values could be reduced to zero. If this happened, your policy would terminate.

Large Premium Payments Could Mean Tax Consequences Under Modified Endowment Contract (MEC) Rules

When making significant changes to your policy or pre-funding it with hefty premium payments, you must take into account the modified endowment contract (MEC) restrictions. In the event that your policy is categorized as a MEC, any distributions or loans made from it may be penalized if they are taken out before the age of 59½. Additionally, these payments may be subject to adverse income tax treatment. You may be eligible for this tax trap if you arrange your VUL insurance to obtain a high cash value with large premium payments. For further information, speak with your financial counselor or insurance agent.

Changes to Death Benefit Level or Option Could Be Potential Tax Trap

The insurer must bear a specified level of risk for the policy to qualify under the tax rules as life insurance. There needs to be a "corridor" between the death benefit and the cash value. Put another way, there must be an insurance component to the death benefit; it cannot be made up entirely of cash value. A "force-out," or the release of policy money to maintain the corridor between the cash value and the death benefit, may result from reducing your death benefit.

A distribution resulting from a force-out could be subject to income tax to the extent it represents gain under the policy. A change in the death benefit option from option B (increasing death benefit) to option a (level death benefit) during the first 15 policy years could also result in a force-out and potential taxation.

Tip: Check with your insurance agent and/or financial advisor when considering changes to your death benefit level or payment option.

Policy Loans Affect Cash Value

The money you get as repayment for a policy loan comes from the insurance company's general fund. Your cash value account isn't really emptied of the loan amount. On the other hand, a portion of your cash value that is equal to the loan amount is designated as collateral. The real returns on the underlying investment are not credited to the collateral amount. Rather, during the term of the loan, this portion of your cash worth is credited at a policy loan rate. Your cash value growth is impacted during the term of the policy loan since a portion of it is not included in the real investment return.

Caution: There is generally no requirement that your policy loan must be repaid, but for any unpaid loan balance, interest accrues on a compound basis. If the value of your outstanding policy loan plus the accrued interest equals the cash value, the net cash value becomes zero and the policy terminates. This could create a large tax liability if your policy had an existing loan and/or cash surrender value totaling more than your cost basis.

Policy Loans Affect Death Benefit

Generally speaking, when your underlying subaccounts see positive returns, your death benefit may be greater than the minimum guaranteed death benefit. Instead of receiving the actual investment return, a portion of your cash value equal to the loan amount is subject to the special loan policy rate while there is an outstanding policy loan. This may have an impact on the growth of the cash value, which lowers the chance that the death benefit will surpass the minimum guaranteed amount. Furthermore, in the event that you pass away with an outstanding policy debt on your account, the insurance company will be the first to get paid back from your death benefit. The policy beneficiary receives the remaining death benefit after the loan is repaid.

Premium Reductions Could Result In Policy Lapse

The possibility to skip or lower premiums may create an incentive to do so, putting you at risk of your cash values dropping to very low or, worse, zero. In such a scenario, you are left with two options: either pay a large premium to maintain the policy and pay the rising insurance costs, which might be highly costly; or let the policy lapse, leaving you without insurance protection.

How to Do It

Determine Your Life Insurance Need and Overall Financial Goals

Before you buy life insurance, you need to know how much insurance you need. Insurance need is based on numerous factors, including your current age and income, marital status, number of incomes in the household, number of dependents, long-term financial goals, level of outstanding debt, and existing insurance and other assets. Your overall financial, estate, and tax-planning goals and your planning horizon should be considered as part of your insurance need evaluation.

Tip: Consult with your financial advisor concerning your need for insurance. Some of the calculations can be complicated.

Decide How Much Risk You Are Willing to Assume

It will depend on your overall attitude toward risk and investing whether variable universal life insurance is the right kind of coverage for you. Variable universal life insurance often makes sense as part of a comprehensive financial plan if you have prior experience with equity investing. Due to daily portfolio fluctuations and the lack of a set rate of interest or guaranteed rate of increase in cash value, VUL may not be the right policy for you if you prefer constant, guaranteed returns and growth.

Obtain a Prospectus for Each VUL Policy You Are Considering

Due to the underlying investment nature of VUL, the Securities and Exchange Commission rules generally require that this type of policy can't be sold without a prospectus that includes full disclosure of all contract provisions, expenses, options, portfolio information, and your rights as a policyowner.

Tip: Read each prospectus carefully and compare the different policies before you buy a policy. Pay attention to the investment objectives of each subaccount, expenses and surrender charges, and other fees and charges for the policies you are considering buying.

Choose an Insurance Amount and Death Benefit Option

When you buy your VUL policy, you must choose a death benefit amount and option, either of which may be changed at any time.

Option A (or option I) pays a level death benefit, while option B (or option II) has an increasing death benefit.

Complete the Insurance Application and Name Your Beneficiary

The insurance company has to receive a completed application form before it can issue your policy. In addition to the general health questions on the application, the process may involve a physical examination, which is typically covered by insurance. The beneficiary designation, which names the person or people who will receive the insurance proceeds upon your death, is an essential component of the application. You can modify the beneficiary designation by adding or deleting a beneficiary or altering the percentages that are distributed as proceeds, unless you select an irreversible beneficiary designation.

Buy the Policy and Pay Your Premium

Knowing how much insurance and what kind of policy is best for your specific circumstances is all well and good. However, your objective will remain unfulfilled if you choose not to purchase the policy! Further, putting off insurance won't benefit your pocketbook because insurance costs rise with age. Delaying also runs the danger of negatively altering your health.

In other words, just because you are healthy and insurable today doesn't mean you will be that way later. Deterioration in your health can mean higher premiums or an insurer considering you to be uninsurable.

Review Your Insurance Need Periodically

The amount of life insurance you need may change over time and with the occurrence of lifetime events. As a result, you should periodically review your life insurance coverage. As a rule, you should review your coverage every three years. Major lifetime events (such as the purchase of a home, birth or adoption of a child, and a change in marital status) are also appropriate times to review your coverage. By routinely checking your insurance need, you can prevent the mistake you can't fix after you die: not having enough life insurance.

Change Your Premium Amounts and/or Death Benefit as Desired

After you have paid your initial premium, you may be allowed to increase or decrease the amount of your premiums. You may even be able to skip premiums, as long as your cash value account has a sufficient balance to cover the cost of insurance and any expenses. Generally, you can change your death benefit and/or premium amounts to meet your changing need for insurance coverage over time.

Tax Considerations

Income Tax

Premium Payments Not Deductible

Life insurance premium payments are generally not tax-deductible expenses.

Policy Loan Proceeds Generally Not Taxable

When you take out a loan against your life insurance policy (except a modified endowment contract, or MEC), the amount you receive is not considered taxable income. This rule applies even when the loan is larger than the amount of premiums you have paid in (except in the case of an MEC).

Example(s): L

Caution: If you cancel your policy while there is a loan balance outstanding, you could be subject to income tax on the amount of the loan (plus any accrued but unpaid interest).

Policy Loan Interest Not Deductible

Interest you pay on a policy loan is not a tax-deductible expense when the loan is for purposes other than business or investments.

Policy Cancellation May Be Taxable

If you cancel (surrender) your policy for cash, the gain on the policy is subject to federal income tax. The gain on a canceled policy is the difference between the net cash value and loan forgiveness amounts and your policy basis.

Caution: You may also be subject to surrender charges. Check your policy.

Caution: Policy fees and expenses are usually charged against the policy in the first few years. As a result, policy surrenders during the first few years of the policy may provide little cash value.

Caution: If you surrender your policy while there is a loan balance outstanding, you could be subject to income tax on the amount of the loan (plus any accrued but unpaid interest).

Policy Lapse May Be Taxable

If you allow your policy to lapse, you could be subject to income tax even if you don't receive any cash from the policy. A policy lapse can occur when you stop paying premiums and don't have cash values available that can be used to pay the premiums. If you have an outstanding policy loan, it is possible you could be subject to tax on the amount of the loan plus any accrued but unpaid interest.

Death Benefits Generally Not Subject to Federal Income Tax

Benefits payable on policy death are typically exempt from federal income tax. One significant exemption is if the policy has been sold or otherwise transferred to another policy owner for a substantial sum of money, in which case it is subject to the transfer-for-value regulation.

Gift Tax

Policy Proceeds Not Considered Gift to Beneficiary

For gift tax reasons, the money paid to a beneficiary of your life insurance policy is not considered a gift.

Policy Premium Payments Generally Not Subject To Gift Tax

If you own a life insurance policy with someone else named as the beneficiary, any premium payments you make to that person are not taxable as gifts under gift tax laws. On the other hand, premium payments made by someone else on a policy you own are regarded as a gift to you and can be liable to gift tax. All coverage premiums paid by someone else on your behalf, however, are usually exempt from gift taxes each year.

Estate Tax

Policy Proceeds Included In Estate Value in Some Cases

If you held any ownership incidents within the three years prior to your death, or if the proceeds are payable to you, your estate, or your executor, then the proceeds of a life insurance policy are included in the worth of your estate. Among other things, incidents of ownership include the ability to transfer the policy's beneficiary, get policy loans, and sell the policy for cash.

Policy Proceeds Often Exempt From State Inheritance Taxes

Life insurance proceeds are not subject to state inheritance taxes in a large number of states.

Questions & Answers

If You Are Covered Under A Group Life Insurance Policy Through Your Employer, Do You Still Need A Personal Policy?

Yes, you should have your own policy outside the group coverage provided by your employer. The policy through your current employer is more than likely not portable--meaning that when you leave the company, your life insurance coverage will not go with you. It is very common for people to change jobs numerous times during their career. Even if you plan to stay with your current job until retirement (assuming your job exists that long), what will you have for coverage afterward? The best way to make sure your family is provided for when you die is to have your own insurance coverage in addition to any provided by your employer. While conversion coverage may be available, it may be expensive and it may offer limited coverage. In addition, it may not meet all of your coverage needs.

Can Your Spouse Own A Policy On Your Life And Name Your Child As Beneficiary?

This can be done, but it shouldn't be. When the insured, the policyowner, and the beneficiary are three different parties, the death benefit may be subject to gift tax.

Can You Name Your Spouse As The Beneficiary On Your Life Insurance Policy If He Or She Is Not A U.S. Citizen?

You can, but there could be estate tax consequences. When your spouse isn't a U.S. citizen and is the beneficiary on your life insurance policy, the death benefit isn't protected by the unlimited marital deduction.

Should You Buy Life Insurance On Your Children?

In some instances it is advisable to buy life insurance on your children, but it shouldn't be done until the appropriate levels of coverage are in place on the lives of the family breadwinner(s) and a non-wage-earning spouse engaged in the care of the children.

Should You Buy Term Insurance Or Cash Value Life Insurance?

It is dependent on your unique situation. The first thing to figure out is not what kind of life insurance to get, but rather how much and for how long. You can go to the financial element after you have provided a quantitative response to the insurance query. It's possible that you require so much coverage that lower-premium term insurance is the only reasonably priced option to obtain it. Once you have determined that you can afford the necessary coverage under either policy type, you should analyze the financial implications of your decision, taking into account things like your tax bracket and the potential rate of return on other assets with comparable risk.

With Cash Value Life Insurance, Does Your Beneficiary Get The Death Benefit Plus The Cash Value Amount?

Perhaps. Examine the policy. A lot of cash value policies are designed so that, upon death, the beneficiary only gets the face value of the policy. The cash value is applied to partially pay off the death benefit. Certain policies have higher premiums but will pay the beneficiary both the face value and the cash value. Check your policy or ask your agent for clarification before assuming that your insurance would cover both sums.

Should You "Invest" In Insurance?

The potential for cash value increase depending on investment results is one of the advantages of cash value life insurance, such as variable universal life insurance. The cash value can be utilized for a variety of things, including retirement income and educational costs. But the permanent death benefit that cash value life insurance offers should usually be the main reason to buy it.

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of  The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

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