Understanding How Variable Universal Life Insurance (VUL) Works

Thang Truong
Thang Truong
Updated on:

You may already know that a Variable Universal Life Insurance Policy (VUL) is a type of permanent life insurance. In fact, it is a special policy that allows you to invest the cash value portion in different ways to grow it faster. Because of the investment options that come with a VUL, many people use it as a potential source of retirement income as they grow older.

How Does a Variable Universal Life Insurance Policy Work?

The variable universal life insurance policy (VUL) is usually set up with a minimum death benefit to be paid to your beneficiary on your death, even if the cash value isn’t very large at that time. As long as you make all of the scheduled premium payments, the death benefit is always paid out to the beneficiaries. 

Be aware that your quoted death benefit may be an estimate that takes into account the assumed cash value of the policy too. You’ll want to check for certain what the minimum death benefit is with your policy. Or, if there is one at all!

In addition, part of your monthly premium payments are used to grow the cash value of the policy. If you just had slow cash value accrual like with a whole life insurance policy, it wouldn’t be enough to live on in retirement. But, VULs incorporate the ability to invest the cash value just like an investment account.

To understand how much cash-value a VUL policy would deliver, by the tool below. It is empowered by Amplify, a digital broker specializing in VUL policies and other permanent life insurance products. They can also help you pull quotes from several companies to help you compare and select the best one for you:

>>MORE: Understanding Indexed Universal Life Insurance – Is It Good for Retirement Savings?

Investing the Cash Value in Variable Universal Life Insurance

Your insurance company will offer a list of securities you can invest the cash value in. Policyholders typically spread their cash value across multiple investment accounts, called ‘sub-accounts’. Over time, the investments will grow or shrink depending on how that security performs. If you make good choices you can grow that money a lot. Some policies average about 8% per year in cash-value growth, which over the length of the payment period can add up to a sizable sum.

Keep in mind that there are fees charged by the investment firms managing these securities. You’ll pay administrative fees annually and every time you change investments.

Flexible Premium Payments in Variable Universal Life Insurance Policy

The VUL policy is set up to be very flexible. Most VULs allow policyholders to adjust their premium payments and death benefits as needed. In fact, most insurance providers will set up a minimum and a maximum premium payment, with a few options in-between. As the policyholder, you can decide what to pay from month-to-month. The options vary but can include:

  • Paying the bare minimum to keep the policy from lapsing.
  • Paying a portion of the premiums out-of-pocket and using the cash-value to pay the rest.
  • Paying more than the target premium payment to grow the cash-value faster.
  • Making a single large premium payment when you purchase the policy.
  • Pay a fixed premium for a fixed period

Depending on your own situation, you can work with your licensed life insurance agent or advisor to design how to pay premium for your variable universal policy. Your goal can be paying a fixed premium in your working years, ie. when you are still earning income, and then withdrawing money to supplement your income when you stop working, similar to a case we illustrate below.

>>MORE: Case Studies of Universal Life Insurance (For guaranteed universal, indexed universal, and variable universal policies)

Taking the Money Out of Variable Universal Life Insurance Policy

After the cash value has grown for a period of time, say by the time you retire, you can begin making withdrawals or taking loans against the insurance policy. Most policyholders will make minimum withdrawals from the cash value to maximize the length of time they receive an income in retirement. Keep in mind the VUL is not usually relied on as a sole source of retirement income, but a supplemental income. People can pair it with their Social Security or a work pension. 

>>MORE: How to Use Life Insurance in Retirement Planning? A Case Study

Most variable universal life insurance policies are designed to distribute money to policyholders as “Switch at basis”, which means that policyholders will withdraw money from the policy first, as in partial withdrawal, until total withdrawal is equal to all premiums paid-in. The withdrawal doesn’t incur any costs to the policy. After that, it will switch to standard loans, which means that policyholders will take money out of the policy as loans against the cash value account in the policy. Insurance companies usually charge an interest rate on the loans and deduct interest payment from the cash value account of the policy as well.

The great advantage of having supplementary income from cash distribution of variable universal life insurance policy, or any permanent life insurance policy for that matter, is that you don’t have to pay income tax on the cash distribution from the policy that you receive. This is a huge benefit, especially during retirement years. Learn more about the tax benefits of life insurance, compared to other retirement and investment accounts.

Want to see how much cash you can take out of a VUL policy, you can use the tool below. It is powered by Amplify, a digital broker specializing in VUL policies. They can also pull several VUL quotes from insurance companies to help you compare and select the best one for you:

Fees and Interests in a Variable Universal Life Insurance Policy

There are two types of fees in a variable universal life insurance policy:

  • The first is investment management fees: Similar to having an investment account that invests in a mutual fund or ETF or index funds, you have to pay investment management fees. It is usually low in a variable universal life insurance policy since insurance companies usually invest in low-cost ETF or index funds.
  • The second is fees associated with withdrawing money from your cash value . These are fairly small, so won’t impact your policy much. It is usually a fixed amount for each distribution. For example, $35 for each distribution. If you receive cash distribution annually, you will have $35 a year.

If you take out a loan, rather than making a withdrawal, there will be interest charged on the loan. Depending on how large the loans become, the interest could start impacting your policy’s cash value and potentially put it at risk of lapsing. However, if you start the policy with a goal to receive cash distribution to supplement your retirement income, the policy should have been designed to account for all interest payment from the cash value account already.

>>MORE: The Differences Between Variable Whole Life Insurance (VLI) and Variable Universal Life Insurance (VUL)

A Sample Case Study of Variable Universal Life Insurance Policy

To give you a better idea of what a VUL looks like in action, we’ll pull the illustration for an accumulation VUL from John Hancock. The illustration is for a woman, 42 years old, in good health who is looking to invest $6,000 annually for about 18 years until she is 60 years old. She will invest a total of $108,000 into the policy with 18 years of premium payments.

She’ll be drawing money from the VUL cash value from the ages of 61 to 100 years old at a rate of about $1,069 per month (or $12,829 a year). For 40 years, she will receive a total of $513,160 in cash, without paying any pennies in income tax. This will deliver 4.75X return on her investment in the variable universal life insurance policy and this doesn’t count death benefit yet.

Her policy’s cash value is invested in over 50 different securities, including different:

  • Bonds
  • Indexes
  • Mutual Funds
  • ETFs

The securities selected will be a health mix of aggressive and conservative securities, including a couple fixed rate indexes. When creating your policy portfolio, you’ll be able to pick whatever ratio of securities you like. Just remember that if your investments don’t do well, your cash value may not grow and it could even lose value!

With regular contributions of $500 per month and an assumed gross rate of return of 8% and minimum fees, her cash-value will grow to about $185,000 by the time she turns 61 years old. The total death benefit will be about $366,000. 

At this point, she will start drawing her retirement income of about $12,829 per year. The policy is designed to allow her to continue drawing income until she reaches 100 years old. She doesn’t have to keep making premium payments as the payment schedule is considered ‘paid-up’ and her cash-value will remain invested in different securities so it continues to earn interest. 

However, the steady rate of withdrawal does gradually deplete her cash-value and subsequently the death benefit must continually be lowered to keep the policy in force. 

AgeCash-ValueTotal Death Benefit
70$175,887 $249,556 
75$170,341 $183,511

By 100, her VULs cash value and death benefit should be about $46,600. If the policyholder dies at any point during her withdrawal period, the insurance company will need to calculate the total death benefit to pay beneficiaries based on the minimum death benefit and the cash value of the policy.

If you are interested in getting your own VUL quotes, you can work with a digital broker specializing in VUL such as Amplify. They can help you pull quotes from several companies and help you compare and select the best one for you:

Growing the Death Benefit Again

Assuming that the policyholder stops making withdrawals from her account and continues living, her policy will start growing again. This Accumulation VUL from John Hancock has an endowment age of 125 years old at which time the insurance company will pay a lump sum to the policyholder to cancel the policy. By the time she reaches 125 years old, the policy should be worth about $256,600.

Let’s take a look.

AgeCash-ValueTotal Death Benefit

Is a VUL Better or Worse than Investing the Money Separately?

Many people wonder if purchasing a VUL policy is really the best option. They see the amount of money that goes into premium payments and wonder if they couldn’t get better growth just investing directly into the stock market with a similar mix of assets. 

Variable Universal Life Insurance offers policyholders the best of both a life insurance policy and an investment account. You’ll have a decent sized death benefit that will go to loved ones, even if you pass away while young. Plus, the policy allows you to grow the cash value into a sizable sum for retirement income. It’s also possible to grow the death benefit back to a large sum if you draw it down below a desired amount. The greatest advantage of variable universal life insurance policy over an investment account is the free income tax when you receive cash distribution from the policy. With an investment account, you may have to pay up to 30% income tax on the amount that you receive during your retirement years.

Plus, it’s hard to keep investing $500 a month into an investment account when it’s not a required payment. If you want to maintain that life insurance policy, you are forced to continue paying the minimum premium amount. This can help ensure that there will be money set aside for retirement for policyholders.

>>MORE: Is Whole Life Insurance Good for Retirement Savings?

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Thang Truong
Thang Truong

Thang Truong covers small business insurance and small business success at BravoPolicy. He is a licensed P&C insurance agent. Previously, he held product leadership positions at realtor.com, Capital One, NerdWallet, and Mulberry Technology. He holds a MBA degree from UC Berkeley - Haas School of Business.

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