Variable Universal Life Insurance
Variable Universal Life is a permanent life insurance policy where the cash value is invested in funds or fixed accounts providing opportunity for growth. Its structure allows for flexible premium payments and an adjustable death benefit, which can be impacted by the investment performance of the cash value. Because of its variable rate of return, a VUL offers more flexibility and growth opportunity than traditional insurance policies, but also comes with more market risk.
Sales of VULs continued to increase from 2018 to 20191. The biggest driver of growth for VULs stemmed from protection-focused consumers, with new premium growing 23% compared to a 10% decrease in accumulation products. In Q2 of 2019, VULs held a 6% market share of total individual life insurance, due in part to investor concern with rising volatility and the specialized usage of VULs.
These measures are created within the context of insurance products.
How They Work
When premiums are paid into the VUL, the insurance company deducts mortality and expense charges (M&E), and the remaining assets are invested into subaccounts. The invested cash value grows tax-deferred until withdrawals are taken from the policy. If the account performs positively, the cash value is credited up to a maximum cap; if it performs negatively, the policyowner may need to pay higher premiums to cover the cost of insurance and rebuild cash value.
Unlike a variable annuity, withdrawals from a VUL are received cost basis first (FIFO), meaning the total amount of contributions to the account can be withdrawn tax-free. Once basis has been depleted, the remaining withdrawals on investment performance will be counted as taxable income. Rather than take withdrawals from the investment performance, insurers allow policyowners to take a loan against the accumulated cash balance. These loans accrue interest but are not taxable as income unless the policy lapses. Additionally, the death benefit paid by a VUL is tax-free in most cases, which can provide unique tax advantages over other products.
Problems with Commissioned VULs
Commissions paid to agents for the sale of a VUL policy can be some of the highest in the industry, in some cases, between 70% and 100% of total first year premiums. This means that in the first year, there will likely be no cash value built within the policy. Agents typically continue receiving smaller commissions beyond the first year, meaning 15%-25% of premium payments could go to cover those commissions and other administrative expenses. Because commissions are removed from the VUL purchase, cash value can grow at a faster rate, giving clients more long-term growth potential.
How to Think About Commission-Free VULs
When your client needs:
LEGACY PLANNING: VULs are attractive options to help clients with legacy planning needs or estate tax concerns. VULs can provide numerous tax benefits during the client’s lifetime, along with the tax-free transfer of assets at death, which is not available with most strategies.
LIFE INSURANCE: Clients who wish to create a long-term death benefit and lean on their RIA to manage additional cash value will be attracted to the VUL. Although VULs carry market risk, they can allow for the purchase of higher death benefits due to higher potential returns. The flexibility of the VUL also allows the client to make changes to their premium, access their cash value, or change their death benefit value and structure.
RETIREMENT INCOME: Commission-free VULs allow for some of the highest cash value accumulation opportunities due to the lack of commission and variable structure. The FIFO treatment on withdrawals allows clients to create a potential tax-advantaged cash flow, critical for high net worth clients as well as clients under 59.5 who generally are not able to pull from qualified assets.
WEALTH ACCUMULATION: Assets used to purchase a VUL are invested into subaccounts, which perform similarly to mutual funds. These assets grow tax-deferred throughout the life of the policy, allowing for greater accumulation potential.
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