Variable Universal Life Insurance (VUL)
Variable universal life insurance (VUL) is a form of cash-value life insurance that offers both a death benefit and an investment feature. The investment amount for variable universal life insurance (VUL) is flexible and may be changed by the insured as needed, though these changes can result in a change in the coverage amount. Payments are paid into the investment component. Each year, the life insurer takes what it needs to cover mortality and administrative costs. The rest remains in the separate accounts. The policy stays in effect as long as the cash value is sufficient to cover the cost of insurance. Loans can be taken against the cash value of the policy. Fund values for variable universal life insurance, are kept in an insurer’s separate account and interest accrued under these contracts are not guaranteed and may in fact be negative since interest is a function of the change in the market value of the separate account assets. As a separate account product, the policyholder may choose from a variety of underlying investment accounts whose values fluctuate with the performance of the underlying assets.
The amount of your policy’s death benefit is determined by the amount of insurance purchased (or the specified amount of the policy) and whether the insured chooses to have any investment performance added to the death benefit. It is generally paid income tax free without the delays and expenses of probate and to the beneficiaries—a benefit only available on life insurance. As with all life insurance, the guarantees of the policy are only as good as the the claims-paying ability of the issuing insurance company.
Variable universal life insurance establishes a tax-free investment environment, at a very low cost, where there are a number of investment alternatives. For the variable universal life products offered through RetireOne, the investment advisor manages the assets in the insurance policy.
- Tax deferred growth of cash surrender values while a policy is in force
- FIFO withdrawal status on premiums paid into the contract
- Income tax free policy loans from policies that are not Modified Endowment Contracts
- Income tax free death benefits (may be subject to estate tax if policy is owned by the insured)
Generally, the insured can access the cash surrender value in the policy through loans or partial withdrawals. Loans and withdrawals are subject to restrictions and will reduce the policy’s death benefit and available policy value. Excessive loans or withdrawals may cause the policy to lapse. Unpaid loans are treated as a distribution for tax purposes and may result in taxable income.
There is a limit to how much premium can be put into the investment account in the first seven years for the policy to retain all its tax advantages and on-going tests as the investment account grows. If the policy fails this tests, then it becomes a Modified Endowment Contract (MEC). While a MEC still offers a tax-free death benefit and tax-deferred growth potential, there are income tax implications if the policy owner borrows, withdraws from or surrenders the policy.
There are tests if the premiums exceed 7-year IRS guidelines (which vary by age and gender of the insured and must be calculated by the insurance company). Beyond the 7 years, a similar test is invoked if there are material changes to the policy. Examples of material changes include (but are not limited to): face amount increases, exchange of insured, increase or addition of certain riders and plan changes. The test selected can have a significant impact on premiums, cash surrender values and death benefits. These tests limit the account value and premiums paid relative to the death benefit.
A Modified Endowment Contract, or a MEC, is a special type of life insurance under federal income tax law. The law attempts to differentiate between policies that are purchased primarily for tax advantages, versus policies that are purchased primarily for life insurance. Like non-MECS, MECs offer tax-free death benefits and tax-deferred cash value accumulation.
If the policy becomes a MEC and the insured does not take any distributions from that policy during the insured’s lifetime, then there will be no adverse tax implications due to contract’s MEC status. However, any pre-death distributions are taxed as “income first” (not basis first), meaning they are taxable to the extent
of gain in the policy. In addition, distributions are subject to a 10% additional tax, unless the policy owner is over
age 59 and 1/2 or has become disabled.
The policy owner can change the death benefit as needed. Death benefit increases may require new medical information.
Once the insurance company receives the application, then the insurance company will take over the underwriting process. The process is designed so that neither the advisor nor Aria have any access to the clients’ medical information. An insurance company vendor will contact the applicant to schedule a convenient time for a trained medical professional to come to the applicant’s home or office to complete a medical questionnaire; gather weight, height, heart rate and blood pressure information; and collect a sample of blood and urine. We will keep you updated on the progress.
Once the policy is issued, your client will have a ten-day “free look” period. During this time, any initial premium is held in cash or a money market. If the policy is returned within the “free look” period, your client will be refunded in full. If the policy is not returned after the “free look” period, the premium is allocated according to the instructions given on the application.