How Variable Universal Life Insurance Works

One of the great things about permanent life insurance is its combination of a death benefit that never expires and tax-advantaged accumulated cash value. This allows you to protect your family today, plan for your legacy and accumulate funds that you can use at any time for any purpose. It's what makes permanent life insurance one of the most flexible financial tools available. 

With many permanent life insurance policies, your cash value grows over time because the insurance company places your premiums into its general account (after accounting for mortality and expense charges), which each company manages according to industry standards and its own investment philosophy. Basically, the insurance company is managing those dollars on your behalf. However, variable universal life insurance gives you more flexibility in determining how to allocate that money. With variable universal life insurance, you can decide to allocate your cash value to accounts that give you market exposure — potentially allowing the cash value to grow more quickly than in a traditional policy, although you may also expose yourself to a greater risk that you’ll lose value. 

How variable universal life insurance works 

Variable universal life insurance is a type of universal life insurance — which gives you flexibility when it comes to how much you pay in premiums and the amount of your death benefit over time. What makes a variable universal life insurance policy different from a traditional universal life contract is that you have more control in determining how your cash value is invested. This allows you to take a more active role in your life insurance policy. Here’s how variable universal life insurance works. 

You have the flexibility to adjust the premium year to year

Variable universal life insurance gives you the flexibility to adjust the amount of your premium payment (as opposed to having a fixed payment each year). There may be years that you want to pay more into the policy than your minimum premium requires so that you can build more equity. Some years, you may need to spend less on your premiums (due to unforeseen circumstances), which is OK as long as you have enough cash value to cover your policy expenses. 

Your coverage is designed to last your whole lifetime 

Unlike term life insurance, which will end at some point in the future, a variable universal life insurance policy will provide coverage for your entire life, as long as you pay sufficient premiums to keep your coverage active.  

Your policy accumulates cash value that grows tax-deferred 

With variable universal life insurance, the premium you pay funds your accumulated cash value, which can grow over time based on the performance of its underlying funds. The accumulated cash value will grow tax-deferred. 

You choose where to allocate your money

With variable life insurance, you can allocate your accumulated cash value into subaccounts that give you diversified options, including exposure to the stock market. You have the autonomy to select each individual investment option and the amount allocated to that fund, or you can use a preselected asset allocation model based on your risk tolerance (conservative, balanced, aggressive, etc.). This can allow you to be more aggressive than you could be with a more traditional whole life policy

Your death benefit and cash value hinge on the performance of the accounts you choose

In bull markets, variable universal life insurance may generate more return for your death benefit and accumulated value than a more traditional policy. But because the markets are dynamic, you also risk losing value in bear markets. 

Tax considerations for a variable universal (VUL) life insurance policy 

One of the benefits of permanent life insurance is that the growth of your cash value isn’t taxed as long as it remains in the policy and the death benefit will be paid tax-free. But your cash value is an asset that you can use at any time for any purpose.1  Accessing your cash value, however, will impact your death benefit and could have tax consequences. Here are a few options to consider: 

  • A loan against your policy. You can take a loan against your policy from the insurance company. Repayment of the loan is flexible, but interest will accrue. Another option is to use your policy as collateral for a loan from your bank. A loan can be a tax-advantaged way to access your cash value. Unlike when you sell non-qualified investments, taking a loan from life insurance means you won’t have to recognize any income (or capital gains) from growth in the policy. 

  • Withdraw a portion of your accumulated cash value. When you withdraw from your policy, you are permanently reducing a portion of your death benefit. By withdrawing a portion of your policy, you can keep some level of life insurance in place while walking away with a portion of your accumulated cash value. This can also be helpful from a tax perspective. That’s because when you withdraw from a policy, you’ll owe ordinary income tax only on any cash value above the basis that you paid into the policy.  

  • Surrender your entire policy. In this case, you can withdraw all the accumulated cash value in your policy, but you also surrender all your life insurance. If your cash value is worth more than the basis that you paid in, you will owe ordinary income tax on that amount.  

If you’re thinking about using your accumulated cash value, your financial representative can help you think through the best options for your situation. 

Is variable universal life insurance the same as variable life insurance and universal life insurance?  

When researching life insurance, you may come across types of insurance called variable life insurance and universal life insurance. It could be natural to wonder if variable universal is the same as the other two. Variable universal life actually combines the other two. Variable refers to the aspect of the insurance that gives you more flexibility with how your cash value is allocated. Universal refers to the flexibility with premium payments and death benefit. 

When to review your variable universal life insurance 

With a variable universal life insurance policy, it’s a good idea to make sure you’re reviewing it regularly. Here are key times you may want to look at your policy.  

During an annual review with your advisor. One of the great benefits of variable universal life insurance is its flexibility. But that also means that you need to make sure you’re managing your premium payments properly. It’s good to check in on this at least once a year with your financial representative. In addition, while you don’t need to change the allocation of your accumulated cash value often, as your risk tolerance changes over time, it may be a good idea to redistribute your accumulated cash value to a less aggressive allocation if your risk preferences have changed. 

When you experience changes in your personal situation. A common time to review variable universal life insurance policies is when you get closer to retirement. It is natural that as you age, you want to be more conservative with the dollars you have spent a lifetime accumulating. Additionally, it is always a good idea to review your life insurance when you have a change in your family situation such as divorce or the birth of a child — these are times you want to make sure the beneficiaries listed are still correct.  

When you update your estate plan. Life insurance beneficiary designations trump what’s in a will. That means any time you’re updating your will, it’s a good idea to also look at your insurance policies or other accounts to make sure the beneficiaries listed match what’s in your will.  

A variable universal life insurance policy can give you the confidence and peace of mind that your family will be protected when you’re gone. In addition, it gives you flexibility and control over how you accumulate cash value, which will become an asset that you’ll be able to use throughout your life. 

1 Policy loans, including any accrued interest, must be repaid or will reduce the policy’s death benefit.  If loans equal or exceed the accumulated value, the policy will terminate if additional cash payments are not made. 

Depending on the performance of the underlying investment options, the accumulated value available for loans and withdrawals may be more or less than the total premiums paid. Policy loans or withdrawals may have important tax consequences.   

Variable contracts have limitations. You should carefully consider the investment objectives, risks, expenses and charges of the investment company before you invest. A registered representative can provide you with a policy prospectus as well as prospectuses for the funds that will contain the information noted above and other important information that you should read carefully before you invest or send money  

It’s important to remember that all investments carry some level of risk.  No investment strategy can guarantee a profit or protect against a loss.   

Issuer: The Northwestern Mutual Life Insurance Company, Milwaukee, WI. 

Principal Underwriter: Northwestern Mutual Investment Services, LLC (NMIS) (securities), subsidiary of NM, registered investment adviser, broker-dealer, member FINRA and SIPC. 

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