A variable universal life insurance is an interesting product. It combines many of the unique benefits of life insurance with with earnings power of an investment account. Many advisors will point to the high fees of a variable universal life insurance product and declare it a bad investment, but this really only tells part of the story. There are reasons that a VUL will actually be much more beneficial than using other types of life insurance. The success of the product as an investment ultimately comes down to using it the “right” way. The following are reasons why a variable universal life insurance can actually be a really good investment.
A VUL Has Significant Tax Advantages
Despite the high growth potential of the variable sub accounts in a variable universal life insurance product, there are many tax benefits to a VUL over investment accounts. This is because VUL products are taxed in the same manner as other forms of permanent life insurance.
The Gains Are Taxed Last When Withdrawn -FIFO
When gains are taxed last, it increases the ability of your investment account to grow. Life insurance has this unique benefit. This is part of the reason why many people consider life insurance a worthwhile investment.
Life insurance withdrawals are taxed in an opposite way from investment account withdrawals. Normally when a security within an investment account is liquidated, the gains are taxed first. Even if the money stays inside the account (in a non-qualified account) any taxable sales must be reported for income tax purposes.
In a VUL account, instead of taxing the gains of the account first, the gains are considered to be the last money out of the contract. This means that the costs basis (any money that you added into the contract) is considered the first money out. This makes VULs more tax efficient because a significant portion of money can be withdrawn from the contract completely free of taxes. This reduces the amount that you need to withdraw (calculated after tax) to satisfy your needs, and leaves more money in the policy to compound for a longer period of time.
Loans Are Allowed Tax Free (That Do Not Need To Be Repaid)
Life insurance owners are given a great feature with their policies, the ability to take loans. In fact, they are even allowed to take loans from their policies completely tax free. This tax free benefit allows owners to withdraw earnings during their lifetime without paying taxes on them! This is opposed to withdrawals, which do require any gains to be taxed.
An owner could hypothetically have a VUL policy that makes a return many times their original investment, they could pull almost all of the money out with a loan (leaving enough to cover premium charges) and they would not pay any taxable income on this money. The beneficiaries can even still get a death benefit from a policy like this if the face amount is large enough. The one consideration when taking a loan is that a loan is deducted from the face amount when death benefits are calculated (assuming a level death benefit option is chosen).
Loans never need to be repaid by the owner and the policy will always stay in force as long as sufficient cash value exists or payment are made to cover the cost of the insurance.
The Owner Can Re-Allocate (Make Trades) Without Taxes
As long as the money stays within a VUL policy, there are no taxes on any trades. Even if a particular security has a gain in the account, the money can be moved to other investment divisions without incurring any tax liability. The ability to re-balance or re-allocate without incurring taxes is an overlooked benefit. Any non-qualified investment account would incur taxes on liquidations of securities with gains. The ability to place trades without any taxes is extremely valuable over the long run to increasing the net return of any investment.
Life Insurance Death Benefit Proceeds are Tax Free
In most cases, the proceeds from a life insurance claim are paid free of any taxes. So if your goal is to pass something on to the next generation without any taxes, a VUL is a great way to combine the earning power of an investment account with the tax benefits of life insurance.
The death benefit of a VUL can be structured in many different ways. For people looking to put away a lot of money, they can get what is called a CVAT (cash value accumulation test). This type of policy actually increases the face amount if the account grows large enough. This ensures that you have room to save more money into your policy, and that you will always be passing along a higher value to the next generation than what is in the investment account.
VULs Make Money When They Are Well Funded
The key to making money in a VUL product is to fund it well in the early years of the contract. This reduces insurance charges, and gives the investment accounts the most amount of time to compound in growth. If you want to buy a variable universal life insurance contract, make sure that you understand how it works and how to fund it properly so that it provides the most benefit to you and your family.