The Risks and Rewards of Variable Universal Life Insurance Policies
Variable Universal Life insurance (VUL) policies are supposed to combine the benefits of life insurance, a savings account, and an investment portfolio. “Variable” policies invest part of the investor premiums, and “universal” policies last for the insured’s lifetime. VULs have two components: the savings account and a tax-free death benefit set aside for beneficiaries. The issuer divides the savings account into sub-accounts to use for investing. The sub-accounts may include a guaranteed premium account (GPA), a fixed account that accrues interest and does not take on risk.
Variable Universal Life Insurance policies, or VULs, might look good on paper, but the reality comes with a myriad of steep fees and inflexible terms. And while variable universal life insurance policies have the potential to generate interest, they also have the potential to lose money. Many investors want VULs because of the death benefit, which comes without any income tax burden for the beneficiary. Unfortunately, this tax advantage may disappear with the rest of the policy since VULs are especially prone to lapsing. Investors who want to protect their beneficiaries with a death benefit may not be using their money as effectively as possible.
What FINRA Wants Investors to Know About VULs and Risk
The word “variable” in any investment indicates some significant risks. Various risks and outcomes are associated with Variable Universal Life Insurance policies, including that the policy could lose value or lapse altogether. Variable Universal Life insurance can be complex, and policies come with more fees than an ordinary life insurance policy. The total amount of premiums paid into a VUL do not go toward investments but, in part, must cover fees for managing the investment portfolio.
Investors should know that because these policies invest in securities, they fall under the purview of the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC). That means a broker or a financial advisor must only recommend VULs that adhere to FINRA Rule 2111, which states that an investment must suit their investor’s age, investing experience, risk tolerance, and financial goals.
Variable Universal Life Insurance Vs. Term Life Insurance
Variable Universal Life insurance policies are a form of whole life insurance, meaning they last for the insured individual’s entire life — so long as the insured keeps paying their premium and the insurance company remains in business. Whole life insurance is also referred to as permanent insurance. This is opposed to term life insurance, which covers the insured for a set number of years.
How Do Death Benefits Work?
Policyholders can typically choose from level death benefits or cash value death benefits, although issuers may structure their death benefits differently.
Level Death Benefit: This benefit pays out the face value of the policy at the time of purchase.
Cash Value: Beneficiaries receive the policy’s cash value as well as the face value. Investors should note that these types of death benefits often come with additional fees.
Insurance companies tend to promote these products as a one-stop shop addressing all an insured person’s financial needs. The reality is that these financial goals (savings, investing, and insurance) do not necessarily work to the investor’s best advantage when combined.
Variable Universal Life: Pros and Cons
For every “pro” of a VUL, there is a con that undercuts its supposed benefit.
Pro: Investors can withdraw money from their VUL.
Con: These withdrawals make it more likely that the policy will require higher premium payments at some point. Also, these loans come with steep interest rates.
Pro: Tax benefits. The withdrawals from a VUL are tax-free. Interest gained on the investments is also tax-deferred.
Con: The tax benefits can disappear if the policy lapses. At that point, the outstanding loans become taxable. If their accounts have appreciated in value, they will have to pay taxes on gains. It is not unlikely that the policy will last if the investments perform poorly after the investor makes withdrawals.
Pro: Flexibility. Investors have some input into the amount they pay in premiums as well as the frequency of those payments.
Con: Difficult to research. Many policies are difficult for investors to research on their own, even if they come with a prospectus.
Pro: Tax-free death benefit for beneficiaries.
Con: The death benefit can easily be reduced. If the investor dies with outstanding loans, those must be paid off before the beneficiaries receive the death benefit.
Pro: VULs come with a savings account, forcing investors to put some of their funds into savings.
Con: The savings are not guaranteed. The issuer uses the savings account to invest, and these investments might lose money, which may negate any supposed savings benefits.
Con: Investments are also limited by the issuer. Investors may be able to find better investment vehicles on their own or by working with a trustworthy financial advisor.
Con: Interest rates can negatively affect insurance rate premiums. What may have started as a modest payment can become extremely burdensome later in life.
Variable Universal Life Insurance Fees
VULs may come with the following fees:
- Mortality and expense risk fees
- Investment management fees
- Surrender charges
- Withdrawal fees
- Policy loan interest
Brokers should accurately describe these fees to their investors and communicate how they might affect returns.
Is Variable Life Insurance a Good Investment?
Peter Lazaroff, a Chief Investment Officer at a financial planning firm, told The Wall Street Journal, “Nearly everyone needs life insurance, but it’s easy to end up with a bad policy.” In the article, he states that most people are better off with term life insurance rather than permanent—a.k.a. universal—life insurance. Lazaroff argues that buying permanent insurance is a waste of money since the premiums paid out in permanent life insurance could be invested without having to pay the fees associated with a VUL.
With term life insurance, the term could end once the insured individual retires, when their beneficiaries are less likely to depend on them for financial support. Life insurance is supposed to protect dependents from the unlikely event their source of financial support dies before they can be financially independent. For this same reason, Lazaroff argues against young, single, childless people from buying whole life insurance—even though certain brokers might argue that it’s a good investment since the price is low. The low prices do not justify the opportunity cost of investing money elsewhere, especially when there are no beneficiaries to benefit from life insurance.
Variable Universal Life Insurance Fraud Lawyers
Because VULs are securities, a securities fraud attorney can help you recover your losses through FINRA arbitration or mediation.
In addition to the ongoing fees that investors might pay, investors should consider the VUL salesperson’s financial incentives to make the policy seem like the answer to all an investor’s wants and needs. They could earn steep commissions on VUL policies. If you believe your broker may have sold you a VUL that did not suit your needs, do not hesitate to reach out to the securities lawyers of Kurta Law for a free case evaluation.