Variable Universal Life Insurance
Variable universal life insurance (often abbreviated as VUL) is a type of life insurance that builds cash value. In VUL, the cash value can be invested in a variety of segregated accounts, like mutual funds, and the choice of which of the available segregated accounts to use is entirely up to the contract owner. The “variable” part of the name refers to the ability to invest in separate accounts that vary in value because they invest in the stock and /or bond markets, which is why they differ. The “universal” part of the name refers to the flexibility owners have when paying their premiums. Premiums can range from zero for a given month up to a life insurance maximum set by the Internal Revenue Code. This flexibility is comparable to whole-life insurance with fixed premium payments, premiums that you usually can’t miss without canceling your policy (though you might exercise the automatic premium loan feature, or forgo dividends to pay your whole-life premiums).
Variable Universal Life is a form of permanent life insurance because a death benefit is paid whenever the insured dies, as long as there is enough cash value to cover the premiums in the policy. For most (if not all) VULs, unlike whole life, there is no endowment age (cash value equals the age of death benefit, which is usually 100 years for whole life). This is another major advantage of VUL over the whole life. In a typical whole life insurance policy, the death benefit is limited to the denomination specified in the policy, which is paid in full at end-of-age. So, whether it’s a death or a donation, the insurance company keeps the cash value accumulated over the years. However, some participating whole life insurance policies offer riders that they designate any dividends paid on the policy to be used as a “paid surcharge” on the purchase of the policy, increasing the cash value and death benefit over time.
If investments made in a separate account are better than the insurance company’s general account, a higher rate of return than the fixed rate for the entire life insurance period may occur. A combination of years with no pension age, increasing death benefit, and if a high rate of return is obtained in a separate account on a VUL policy; this may give the owner the benefit compared to a life insurance policy of the same amount paid in premiums Or beneficiaries bring higher value.
Regulation of VUL Providers
Because separate accounts are securities, representatives providing VUL must work by the securities regulations of the country or province in which they operate. And because VUL is a life insurance policy, VUL can only be sold by a representative who is properly licensed to sell life insurance in the region in which it operates. The insurance company offering the policy must also be licensed by the “insurer”.
This dual regulation helps protect consumers, who can check the records of violations of any provider listed by the Regulation SRO (Self-Regulatory Organization) or the ProvincialSecurities Commission.
- The United States. VULs can only be sold in the United States by representatives who have a “producer” life insurance license in the state in which they operate. Insurance companies that offer policies must also be licensed in the states as “insurers.” Because separate accounts are securities, representatives must be registered with the US SRO, Financial Industry Regulatory Authority (FINRA) through a broker /dealer, and be registered with FINRA in person. (FINRA has an online database that investors can use to find illegal and regulatory actions by any broker or broker/broker.) Representatives’ securities registration facts will appear as “variable” on their state insurance licenses, as described in “Eligibility for Life” . and variable products. (The exact wording may vary from state to state.)
- Canada. A VUL is a life insurance policy that can only be sold in Canada by a life insurance licensed representative registered with the insurance regulator within its provincial jurisdiction. Representatives must comply with the life insurance regulations of their respective provinces (usually the provincial Insurance Act). And, because a VUL is a life insurance policy, providers must comply with the National Life Insurance Regulations (the “Insurers Act”) established by the Office of the Superintendent of Financial Institutions (OSFI). Because values are not currently considered securities in Canada, VULs are subject to less regulatory scrutiny than typical securities products. In Canada, there is no real difference between universal life and variable universal life.
Variable universal life insurance has special tax benefits under the US Internal Revenue Code. The cash value of life insurance enables investment gains without generating liquid capital income tax as long as the definition of life insurance is met and the policy remains in force. Tax-exempt investment income can be considered to be used to pay the insurance costs within the policy. See the Tax Benefits section for more information.
In a needs analysis-based theory of life insurance, life insurance is only required if the assets a person leaves behind are not sufficient to meet the income and capital needs of their dependents. In one form of variable universal life insurance, the cost of insurance Purchased is based solely on the difference between the death benefit and the cash value (defined as the net amount at risk from the insurer’s perspective). Therefore, the greater the accumulation of cash value, the less net at risk, and the less insurance purchased.
Another use of variable universal life insurance is among the relatively wealthy who donate money to their children each year to enroll in a VUL policy on a tax-free basis. In the US, there are often people with high enough net worth that they are about to pay estate tax and give the money to their children to protect the taxable money. Typically, this is done in a VUL strategy, as this allows for tax deferral(for which there is no option other than tuition savings in an education IRA or 529 plan), permanent life insurance is provided, usually by applying to the policy Borrowing is tax-free.
By allowing the contract owner to choose to invest within the policy, the insured assumes the risk of the investment and derives a greater potential return on the investment from it. If the ROI is poor, it may cause the policy to fail (no longer exist as an effective policy). To avoid this, many insurance companies offer guaranteed death benefits up to a certain age, as long as a given minimum premium is paid.
VUL policies have a lot of flexibility in choosing how much premium to pay for a given death benefit. The minimum premium is mainly influenced by the contract features offered by the insurance company. To maintain the death benefit guarantee, a specified premium level must be paid monthly. For this policy to be effective, there is usually no premium to be paid as long as there is enough cash value in the policy to cover the cost of coverage for the month. The maximum premium amount is largely influenced by life insurance regulations. Internal Revenue Code Section 7702 sets limits on how much cash value can be allowed for a given death benefit and how much premium can be paid (both in a year and for a certain period).In terms of cash value growth, the most efficient policy will be the highest premium paid for the lowest death benefit. In this way, the cost of insurance will have a minimal negative impact on the growth of the cash value. In extreme cases, it would be a life insurance policy with no life insurance component and entire life insurance. cash value. If it received favorable tax treatment as a life insurance policy, it would be the perfect tax haven, pure investment income, and no insurance costs. When variable universal life policies were first introduced in 1986, contract owners were able to make very high investments in their policies and receive extraordinary tax benefits. To curb the practice, but still encourage people to buy life insurance, the IRS has established guidelines on allowable premiums for a given death benefit.
The standard set has two aspects: defining the maximum cash value of each death benefit and defining the maximum premium for a given death benefit. If the maximum premium is exceeded, the policy will no longer qualify for all the benefits of a life insurance contract and will be referred to as a modified endowment contract or MEC. MECs still receive tax-free investment income and tax-free death benefits, but MEC’s cash value withdrawals are on a “last-in, first-out basis, with income first withdrawn and taxed as ordinary income. If the cash in the contract value exceeds the specified percentage of the death benefit, the policy will cease to qualify as life insurance at all, and all investment gains will be taxed immediately for the years in which the specified percentage exceeds the specified percentage. To avoid this, the contract will have a death benefit Benefit is defined as the higher of the original death benefit or the amount required to meet IRS guidelines. The maximum cash value is determined as a percentage of the death benefit. Percentages range from around 30% for younger policyholders, down to 100-year-old policyholders 0%.
Maximum premiums are determined by Internal Revenue Service (IRS) guidelines, qualifying(such as a purchase or death benefit increase), increasing at a rate of 6%, and using the maximum insurance guarantee cost in the policy contract, will be earned at age 100 Policy (ie cash value equals death benefit). More specific rules have been adjusted for premiums not paid in equal amounts within seven years. The full maximum premium (greater than 7 years premium) can be paid in one year, and no further premiums can be paid unless a death benefit is added. If the normative premium for Year 7 is exceeded, the policy becomes a MEC.
Adding to the confusion, the seven-year MEC premium level cannot be paid annually in VUL for 7 consecutive years and still avoids MEC status. If the non-MEC status is required, in practice only about 4 years of MEC premium levels can be paid before additional premiums can be paid. There is another type of premium that is designed to be the maximum premium that can be paid each year when the policy is in force. This premium comes under different names for different insurers, and some call it a guideline maximum premium. This is usually the premium for the most efficient use of the policy.
The number and type of choices available vary by company and by strategy. Current-generation VUL policies have a variety of sub-accounts into which policyholders allocate their cash refund value. These newer policies typically offer 50 or more separate accounts, covering the entire spectrum of asset classes and management styles.
Separate accounts are organized as trusts to be administered for the benefit of the insured, so named because they are kept “separate” from the life insurance company’s “general account”. They are similar to mutual funds but have different regulatory requirements.
- Taxes slow cash surrender value growth while the policy is in force
- FIFO withdrawal status of premiums paid to contracts
- Tax-exempt policy loans from policies that are not modified endowment contracts
- Income-tax-free death benefit (may be subject to estate tax if the policy is owned by the insured)
Taxes are the main reason for high tax(25%+) looking to use VUL to replace any other accumulation strategy. For someone taxed at 34% (federal and state), the return on investment on a separate account will average 10%, and at age 75, the policy’s death benefit will have an internal rate of return of 9%. To get a 9% return on a regular taxable account, in the 34% tax bracket, you would have to earn 13.64%. Another option for this, within the 34% tax bracket, is to consider a variable annuity that doesn’t limit contributions and draws from contributions without using contract annuities.
Other alternatives for those in the 34% tax bracket who own their own company are to consider a SEP IRA, 401k, or retirement arrangement from a corporate perspective, or set up and consult a tax professional.
These figures assume that payouts may vary between companies and assume that the denomination of funds for VUL is the lowest denomination of the premium level. The cash value will also be used to fund lifestyle or personally managed investments tax-free in the form of refunds of premiums paid and policy loans (to be repaid through the death benefit upon death).
Universal lifespan at risk of change
- Insurance Costs – VUL’s insurance costs are usually based on a recurring fee, and as the insured age increases, the risk of death increases, thereby increasing the insurance cost. If not properly monitored, the cost of insurance may end up exceeding the out-of-pocket outlay, resulting in savings. If it goes on like this over the long term, savings will be depleted and the insured can choose to increase their out-of-pocket payments to cover higher insurance costs, or cancel the policy, leaving them with no savings, no insurance, or very expensive insurance.
- Cash Out – The cash required to effectively use a VUL is usually much higher than other types of insurance policies. If the policy has insufficient funds, the policy may lapse.
- Investment Risk – Because sub-accounts in VUL may invest in stocks and bonds, the insured now takes the investment risk, not the insurance company. The profit and loss of an investment fund are mainly determined by the liquidity of the stock.
- Complexity – VULs are complex products and as such can easily be used (or sold) inappropriately. For a VUL to work properly, proper funding, investment, and planning are generally required.
General Purpose of Variable Universal Life Insurance
These are features that insurance companies typically sell, but in most cases, VUL restricts the insured to only one of these features listed there. Each of these functions can be implemented in other ways.
- Financial Protection – Like all life insurance plans, VUL can be used to protect families in the event of premature death.
- Tax Benefits – Due to the tax deferral feature, VUL may offer attractive tax benefits, especially for those in higher tax brackets. To achieve these goals, the policy must be adequately funded (though still not a MEC) to receive tax benefits to offset the cost of insurance. These tax benefits can be used to…
- Educational Programs – As long as the policy starts early, VUL’s cash value can be used to help fund children’s education. Also, depositing money into VUL can help children qualify for federal financial aid because the federal government does not consider cash value (Expected Family Contribution) when calculating EFC.
- Retirement Planning – Since VUL has a tax-free policy loan feature, it can also be used as a tax-advantaged income source in retirement, provided that retirement is not far off and the policy is not a modified endowment contract. Again, the policy must be properly funded for the policy to be effective.
- Estate Planning – Persons with substantial estates (property for estates with total assets and prior taxable grants over $5,430,000 must be declared, this estate tax applies to deceased persons who passed away on or after January 1, 2015 ) can sometimes Use the VUL as part of their estate planning strategy to reduce or avoid estate taxes by setting the VUL.Life Insurance Trusts are sometimes called ILITs.
Criticism of Mutable Universal Life
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some general criticism
- Potentially Higher Costs – VUL policies can be more expensive than other types of permanent coverage such as whole life and traditional universal life. The volatility of the cash refund value, especially at later stages, can cause an “average reverse cost” effect, which can lead to higher insurance premiums. Properly funding the contract may reduce this risk, but it cannot eliminate it.
- Some older VUL policies have a limited selection of sub-accounts. The current generation of policies with 50 or more sub-accounts (covering all major asset classes) and more than one sub-account manager has significantly corrected this problem.
- Policy administration fees and insurance costs may increase at the company’s whim, subject to contractual maximums.
- VUL is relatively complex compared to the traditional whole life or periodic life.
Some of the criticism was not about the product, but the sales tactics used by some insurance agents.
- Using current (or assumed) management fees and current insurance fees to predict the maximum stated assumed interest rate (usually 12%), without showing prospects several other assumed rates of return, creates a blue sky problem.
Some regulators have also come under criticism.
- The Financial Industry Regulatory Authority (FINRA) does not allow insurers to use stochastic forecasting (often referred to as “Monte Carlo simulations”) to illustrate VUL policies, restricting agents from using the “straight line”, constant-rate assumption.