Variable Universal Life insurance or in short VUL is sold by insurance agents as a smart investment to unsuspecting people. The pitch usually goes like this:
You invest in VUL. The money in the policy grows tax deferred. You get to choose what you invest in, stocks, bonds, international, you name it. It’s like a super IRA, only way better. When you need money after you retire, you can first withdraw what you put in, then borrow from it, all tax free. When you die, your beneficiaries receive money tax free.
Sounds good? Tax deferred investing plus tax free income after retirement. Who wouldn’t go for it? It’s very enticing but you will see the real story at the end of this post.
VUL appeals to people who hate taxes (who doesn’t?), especially to people who have higher income and therefore in higher tax brackets. After you hear about this wonderful clever way of avoiding taxes on your investment, you go “sign me up!” Uh oh, big mistake. Let’s take a look at a real life example, from this thread on the Bogleheads forum.
Poster John and his wife each bought a VUL policy from a “friend” who works as a financial “advisor” at a “well known financial planning organization” (I’m guessing it’s Ameriprise or formerly American Express Financial Advisors). After 9 months into their policies they put in about $5,000 each for a total of $10,000. Now they realize that their VUL policies have high fees and expenses, to the tune of $1,100 a year. But, if they get out before 5 years, they will lose ALL of the $10,000 they paid into the policies (?!?!) because the first $8,300 in each policy goes toward a “surrender charge” or better put, early termination fee like that on a cell phone contract. In other words, if John and his wife put $3,300 more into each policy, the policies will still suck it all in like a black hole with nothing coming out. They paid $10,000 into two policies but they only filled a little more than half way up the big hole that the VUL policies dug for them.
Despite all the help from other posters on the forum, John’s options are still limited because the policies are designed to trap them in good with high fees and various charges. John and his wife can:
- Keep paying into the policies and get plucked by high fees (not good); or
- Cancel the policies now and receive nothing back (not good); or
- Stop paying premiums and let the policies wind down by themselves (not good)
None of the three options is good. The 3rd option is perhaps the least of all evils. Basically they will let what they already paid pay for the insurance and whatever is left over stays in some mediocre investment options with high fees. Every month more money is deducted from the investments part towards the insurance part and fees. After the 5-year surrender period is over, I doubt there will be anything left. Their policies may end even before 5 years because all the money will have been depleted by insurance charges and fees. That $10,000 is gone. They won’t ever see it again. What an expensive lesson!
I feel really sorry for John and his wife. Having this done to them by a “friend” is even more sad. This VUL saga plays out over and over. It’s almost always the same story. I personally know a small business owner who was sold a VUL policy by his “financial advisor” who is also an insurance agent. The “advisor” has nice sounding credentials like CLU and ChFC. The business owner was quite mad at the “advisor” after I pointed out the fees and expenses printed in black and white in the prospectus. Of course he didn’t read the prospectus because he was busy running his business and he trusted that his so-called “advisor” would act in his best interest. The same “advisor” also sold him load funds, an expensive 401(k) plan for his business, limited partnerships that were impossible to get out of … — altogether the “advisor” cost him more than $200k.
Now let’s get back to the wonderful VUL policies New York Life sells. From an 80-page prospectus of their NYLIAC Variable Universal Life 2000 product:
- 4.5% – 6% charge up front for each deposit, like a load; plus
- $120 a year contract fees; plus
- 0.5% – 0.7% a year for M&E and admin charges; plus
- ~0.8% a year for expenses on investment options
Does it look like a good way of investing money? I like what poster ole meph said [1] on the Bogleheads forum:
“The only way you can benefit from this product is by dying fairly soon.”
Oh wonderful. I’m sure the clients didn’t want to pursue that route when they bought into the VUL policies.
[1] ole meph has been a veteran insurance agent and manager himself for over 40 years.
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Ted Valentine says
I almost got sucked into one of these when I was fresh out of college. I read the thing and the fees looked really bad and I said no. WHEW. There’s some stupid tax I didn’t have to pay! And trust me, I’ve paid plenty of stupid tax.
think like the rich says
thanks for discussing this often misunderstood subject. indeed, this type of life insurance product is antiqued and oversold, mostly due to the high commission available to agents. i would in most circumstances throw annuities into the same pile!
Anonymous says
It’s very sad that you are posting such a mediocre criticism which only exposes your ignorance. I suggest you get a CLU designation or even maybe just a course in critical thinking before you bash products that not only save lives and businesses but also allow tax saving that overshadow the fees discussed.
By the way, if you run a comparison illustration of buying term insurance and then try to get your investment going you will get the benefits of a VUL. Until then do people a favor and shot up.
Harry Sit says
Anonymous,
May I have some more substantive criticism please? If mine was mediocre, I at least let the numbers speak, and readers can draw their own conclusions. Can I see your apples to apples comparison?
Anonymous says
Did you bother to mention the amount of the insurance? Nope! Did you mention one company and use a prospectus from another? Yep! Did you mention whether the premium paid was the minimum or maximum? Nope! Did you bother the take a snap shot of the TOTAL financial situation? Nope!
I will agree that there are many financial folks that sell the policies in a hap hazard way. However, there are many including myself that don’t. Thanks for giving me a black eye for a fight I was never in. Ignorant!!
These policies are right for the right reasons. They are sold to people at a minimum funding level while the client assumes the maximum cash value will be acheived by doing so. THAT is the reality!
If for any reason you have to question whether you can fund it appropriately, you don’t do it. Thats the in your face test that very very VERY few do.
I suggest, Mr. Finance Buff, that you go back to school and learn the up-to-date strategies.
Harry Sit says
Whoa, calm down. Did a prospect of yours read my post and cost you a sale? It doesn’t surprise me that the only people who like VUL are people who sell it.
I linked to the New York Life prospectus because I also linked the article from New York Life. If you want to see a prospectus from Ameriprise, you can find it on their website.
Fees:
* 5% charge up front for each deposit; plus
* way overpriced cost of insurance; plus
* 0.9% a year for M&E in the first 10 years, 0.45% a year for the next 10 years, 0.30% a year afterwards; plus
* ~1% a year for expenses on investment options
Now let’s look at a real life case. I have a $500,000 term life policy which I need for the next 15 years. I won’t need life insurance after that. I’m paying $225 a year for my policy (the Ameriprise policy above would cost over $800 a year). In addition, I have $1,000 a month available for investing. Please show me which VUL policy is better than my current arrangement.
Anonymous says
You have two choices when it comes to long term investment gains:
1. Pay an insurance company (as per your example 5%+0.9%+~1%= ~7%.)
2. Pay the IRS 15% (capital gains).
The answer is likely not that simple though.
Harry Sit says
You are mixing one-time costs and annual recurring costs. In your (1), 5% is one-time, at the time of purchase; 1.9% is year after year. In your (2), 15% is one-time, at the time of sale. Simple math says after 5 years, money paid to insurance company exceeds taxes paid to IRS.
VULs suck says
James Hunt, a life insurance actuary and former insurance commissioner, has evaluated thousands of vuls. He understands these beasts.
Per Mr Hunt, at one time a VUL might have be appropriate for a very small percentage of people.
Obviously, Ameriprise and many other firms have oversold these things. And Ameriprise does not comparison shop for the best vul (like the low-cost Ameritas). They sell people the vul that they are told to sell. The one that makes them, and Ameriprise, the most money.
Currently ia vul no longer makes sense for anyone.
“Since the tax law changes of 2003,
which lowered taxes on qualified dividends and long term capital gains to a maximum of 15%, I have recommended against buying VULs – term life plus a low cost Vanguard stock index fund, say, should work better.” – James Hunt
If you currently own a vul and would like an evaluation at a very reasonable cost, go here:
http://www.evaluatelifeinsurance.org/
Anonymous says
Sir:
There is a situation where I will sell a VUL. If my clients do not have Long Term Carte insurance I will do a non MEC VUL with a LTC rider. It is usually cheaper than LTC insurance or a hybrid like Lincolns Money Guard.
And, unlike pure LTC insurance, if you don’t use it your estate will get the death benefit.
Raj Kumar says
I have the VUL policy. I need to get out of this mess. Can you provide any advise?
Raj
anonymous says
My husband has had a VUL since 1993…If the policy is valued at $100,000, at what point is the policy NOT (notice I said NOT) in danger of elapsing? I ask this because we would like to borrow OR withdraw some of of the money for emergency bills. We are afraid to do so, however, because we are not sure what will happen
Harry Sit says
Anon – You’ll have to contact your agent with that question. You already paid your agent. So use his/her service.
yh says
My friend was sucked into becoming an “associate” despite my best objections and now has bought herself a VUL. *sigh*
Zork Dude says
I have several VULs, I agree completely with the “Black Hole” Theory. The main issue I have with these is that the cost of insurance isn’t just a little higher then buying, say , 20 yr term. It’s about 3x as much. This acts as a huge headwind and makes the thing much less attractive. I cannot get an answer from anybody that estimates the cost of insurance. These things are a joke. I am sorry I have one, but am stuck in it now.
Brad says
Each person’s situation is different and VUL’s are a great tool for people looking to get permanent coverage, invest money for retirement and college education and never be taxed on that money. You would usually use a VUL for people who already have retirement money but will all be taxed at distribution and they are already maxing out thier Roth this is a good tool for this circumstance….. I could sit here and bash term insurance till we are blue in the face….98% of it never gets used. So you can have different oppinions on each product. But each situation is different. Of course there are going to be fees…hello the insurance companies are in this business to make a profit for doing the work that they do. And good advisor’s are going to be upfront with their clients telling them all of these details. Don’t ruin it for those people out there that could benefit from this product.
brian says
I am a 37 year old small business owner who is “to busy” to handle it all. I used an ameriprise rep to advise me on retirement/investment options. I didn’t qualify for the Roth and was advised to buy a VUL from this “friend”. My wife and I both invested 30,000 into the VUL and have felt like prisoners ever since. We were not given “correct” information about the Policy and feel that the amerprise rep mislead? us. We invest $600 dollare into the policy monthly. What are the opptions to get out if it still has cash value. Should we continue to invest and then “get out” with any of our cash left? Can I file a suit against the the advisor? Please help. Brian
Harry Sit says
Brian – I’m sorry to see the same happening to you. You basically have the same three choices as I outlined in the post: (1) Keep paying into the policies and get plucked by high fees (not good); or (2) Cancel the policies now and pay the surrender charge (not good); or (3) Stop paying premiums and let the policies wind down by themselves (not good). There is no good option. Depending on how far out the surrender charge period lasts, one option might be slightly better than the other two.
Scott says
Wow, it would be nice if people had forward vision. If one takes advantage of the low taxes today by paying them, have at least 20 years until a need for cash flow will exist, a cash goal that needs to be met in case of death and they MEC out a VUL, assume the same ROR on any mutual fund available in and out of a VUL, the net after tax of the fund vs the tax free withdrawl that can be taken from the VUL if income vs lump sum is the end goal desired the VUL will CRUSH the Mutual fund in benefit to the living owner and add in the left over DB. It is insane, UNLESS you think taxes will be lower 20 years from now, not to consider a VUL in todays world. If you think taxes will be lower in 20 years, I pity your ignorance. In addition, the cash values have creditor protection in many states, but why would that matter, nobody sues anybody in the USA, right?
Dan says
Add me to the ranks of those trying to best “get out” of a VUL.\I have a strategy in mind. After running some PV projections,the minimum damage strategy seems to be to 1) immediately withdraw all but the surrender value (the max I am allowed to) from the account, 2) stop paying new premiums and then 3)let the policy eat itself up (account value pays the premiums)and ultimately lapse in about 3 years. Given the market, I wouldn’t have any tax implications cause I’ve seen losses not gains.
This is like the third choice mentioned in the discussions above. I’ll call it: “having them buy me 3 years of insurance with the surrender charges.” This at least beats getting nothing out of the surrender charges if I surrender the account now.
But am I setting myself up for other hidden fees and traps? I’d be cutting my losses in half but I am suspicious that the insurance companies would not have closed this exit method by now. I don’t see anything in the details of my contract, is anyone aware of hidden charges in general that could kill my strategy? Thanks. Dan
Dan says
A quick follow-up on my last post. I thought I did my homework and was okay with my VUL, but I still got burned in a clever (unethical?) way.
I understood going in that a VUL’s extra fees and higher insurance costs needed to be weighed against its tax advantages. So I negotiated a lower face VUL with a substantial term rider to tilt the odds in my favor. Then I got busy and didn’t follow through on tracking the account.
The term rider had a much lower insurance rate, but buried in the wording was the hidden fact that the rider’s insurance rate went up TEN-FOLD after year one. Is such an exploding term rider even legal. It seems pretty shady to me. It was very hard to find it in the contract.
I violated my own “always keep to simple contracts” philosophy and sure enough they found a way to burn me. Complexity in financial contracts is way over-rated. It leaves the uninformed open for a kill…and perhaps leaves the economy less stable than would be desired. Back to Term + Roth for me. Jack Bogel’s new book ENOUGH says it all for me.
William says
I was suckered into a VUL. Shame on me . I dumped the worthless adviser and dealt with the insurance company myself after I realized what a mistake I made. The rep at Principal life helped me to reduce my policy to the minimum face amount for tax deferred gains, and the minimum premium to keep the policy active until the surrender charge period is over. $30 a month for 140,000 face value. Not cheap but it’s supplemented by a very cheap 30 yr 350,000 term policy I found myself. I’m hoping the stock market will rebound nicely during the next 8 years of the surrender charge period so that if I decide to cash out the policy I may at least break even. Buy term and invest the rest with a no load, low fee institution like Vanguard. Choose the retirement vehicle the makes the most sense for you, be it a Roth or regular IRA, Simple or SEP IRA. There is even the self employed 401k for business owners without employees. You can max out more than one of these options at once for maximum retirement savings. I’m maxing a Roth IRA and will put any additional savings into a SIMPLE IRA. You don’t need a financial adviser. Do your homework and do it yourself. It’s not that hard. Just educate yourself.
Justin says
These vehicles are of no benefit to 99% of the population. Many agents of WFG and other companies will defend this product as the all purpose investment vehicle. I challenge anyone to defend this product that also has a CFP/CFA designation, oh yeah, not gonna happen. I got out of mine years ago. My buddy still paying his telling me I will be wrong in 20 years doing term and invest the difference. I am kicking his butt right now since I am investing the same amount in a mutual fund and direct stock purchase meanwhile he has to pay more to keep his VUL in place with the hit in the market and rising cost of insurance. Hope he can keep it up with this economy right now, otherwise he won’t make it to the 20 year mark and will lapse having nothing to show for it over the last 5 years. Sometimes it’s better to admit you goofed and cut your losses, I know I did and left that queasy feeling in my tummy back 4 years ago.
J says
When it comes to commissionable products, there is always going to be the battle of what is being sold correctly and incorrectly. It is unfortunate that we must question a professionals motives, but sadly, it is true. This is what I will say on the subject, please, to both sides, do not make blanket statements. While you can be confident in your position, arguing back and forth about who is undeniably right and who is undeniably wrong, is futile. Leave that to that the shock jocks that are trying to sell some books about how right they are the end all be all. I am sure there are professionals on both sides of the coin here, and for those people looking to get good advice, they don’t need a blanket statement, they need a good advisor to look at their particular situation and provide appropriate feedback. Here are the facts: VULs are expensive, Term insurance is not. However, comparing the two on a fee basis is simply silly (one is permanent, one is not). I agree that VULs are mis-sold in about 90% of ALL situations, and unfortunately is done by advisors who do not do their own research on the cost of the products they are selling. VULs charge a high upfront fee, so that the insurance company can provide themselves with financial protection and leverage for volatile markets throughout the life of the policy (they are a business, if that sickens you, don’t buy it). They also charge on an annual basis for the cost of insurance, policy fee, and investment option charges. These charges, however, differ, DRASTICALLY!!!, from company to company, do your research, and don’t tie yourself to a proprietary advisor (one who only sells what’s in his/her bag of products). VUL has it’s place, but it isn’t the glorious silver bullet all advisors make it out to be. Over funded, long term, income generating, flexible investing option, that’s most it. Most large companies offer significant cuts in costs for over funding policies (this makes them the least profitable VUL to the company, and less overall commission for the advisor and those are two typically good things for you). You pay big fees up front, which means you need a long-term outlook, if you have 10 years, typically look elsewhere, minimum of 20 years before you touch it is a good starting point. If you have a large amount of non-qualified dollars (typically cash), and need/want to get them tax-deferred immediately, VUL can be a powerful tool, one because it has pretty flexible purchasing options, most other investments do not, and two, it means you will be over funding the policy, as stated, a good thing. Lastly, if you want income at some point. For most cases, if you are just looking for death benefit, there is typically a much more cost effective way to get it. The income aspect is where you really need to do your research, if the company does not have zero net loans, you are basically paying a lot of money to get a loan in retirement. You don’t need all of those, but, for the most part, there you go, that should sum up 95% of all VUL sales. The remaining 5% are typically advanced sales concept (college planning, trusts, etc.) and I think that is beyond the scope of this chat. There will always remain the constant battle of what method works best. I and everyone else here can show “apples to apples” comparisons (p.s. it more an apples to bananas comparison), and honestly, they don’t differ from a dollars stand point IF YOU FACTOR ALL CHARGES AND TAXES, you need both and often each side will only show you one. Those people looking to have a cheap liquid account of investments and temporary insurance, do not buy a VUL, that’s not what it is made for, there buying term and investing the difference looks attractive. For everyone who wants/needs advice, just be diligent in working with someone that not only you trust, but knows the product inside and out. A good advisor should know every fee and charge, pro and con, and appropriate and inappropriate placement. Find out by asking open-ended questions, “why would you recommend this to me?” and since they will give you a programmed line, follow it with “tell me more about it”, “what are the benefits”, “what are the downsides”, “what would be another option”. You have all the power, because you make the ultimate decision. For the advisors, I am sure the ones who are combative are good advisors who know their products, controversy is a talking point, make it what sets you apart. When a client says, “I have heard bad things are VUL’s, respond to it, simply say “yes, there is some bad press around VULs, let me tell you why…”, a client will respect your honesty, and can draw their own conclusions from the TRUTH about VULs. For the shock jocks, please do not make blanket statements, I have as many success stories about both sides, using VUL and buying term plus investing the difference, each were right for each situation. Lastly, for those who are in a policy that they should not be in, I am sorry, typically there will not be a great exit strategy, and all you can hope for is a rally in the markets that give you decent returns inside the policy. What I will tell you is, look to the prospectus, and see if there are any funding options that will lower your fees, while it may not be a saving grace, it may lessen the blow. I hope this helped anyone who read it.
FatN Happy says
Forget annuities or Vul. For any small business owner I would recommend a 401k plan. For any 1099 or independent contractors you can also get a Solo 401k. No other plan except defined benefit plans allow you to shelter more.
Many providers such as your payroll company can offer these services for very low administration cost, ; of which you can write off as a business expense. These providers if their not an insurance company usually have no cots to invest, no loads sale charges surrenders.. except 12-b1 fees.
On top of that it will help you attract and retain good employees.
With the 401k no one can guarantee performance except the taxes you wont pay. If you fund a modest amount the tax savings will cover the cost of the recordkeeping portion 1-4k year.
Most plans now can be set up with open fund offerings so you can choose which funds you want to invest in and almost all are no load funds.
In addition for any highly compensated individuals the pension protection act of 2006 allows for anyone regardless of income to put up to 15K in the 401k as a Roth contribution. Again NO INCOME LIMIT.
I have sold against annuites for quite some time now… get a calculator and it becomes obvious what you should choose.
Faclon99 says
I wish I had known this 4 years ago! MY wife and I were sold VULs from a “friend”. Long story short – the funds in the VUL were seized by Ameriprise because the values had declined below the surrender charge level even though we DID NOT want to surrender the policies and we were paying the cost of insurance. We were told by our adviser and friend to ignore notices from Ameriprise.
Later our adviser admitted that he regretted selling us these policies. Now Ameriprise is willing to give us back our money (the value in the policies) and waive the charges after we threatened to go to the insurance commissioner.
Its been 4 very very expensive years and the only person who’s got rich is the adviser!!
captain of my ship says
I filed a complaint with my state’s banking and insurance dept. against the adviser who sold me a VUL. It was not an appropriate product for me and other, less expensive options were deliberately not brought to my attention. I was ignorant. The adviser was greedy. It took a while but eventually the insurance company waived my surrender charge and returned the cash value of my policy. I hope the adviser had to return his commission. The lesson here. I am my best adviser when it comes to my money. So is everyone else with their money. Libraries, bookstores and the internet have more than enough information to help the average person take control of their financial future.
aldo says
all good points.. but all I read is complaints from people that have VUL that were not qualified propespects. A lot of VUL are sold as Executive Bonues compensation, Estate Planning purposes and to qualified prospects. It all boils down to time horizon, the prospect needs to make enough money because he or she needs to overfund the policy by at least 100% of target premium. And if it used indeed like a Roth Alternative then you really have limited options when it comes down to tax free income at retirement.
And it also does not help if you did it with an advisor that is looking for a quick buck.
All in all, VUL work extremely well for certain people.
aldo says
to the comment of Captain of my ship.
“The lesson here. I am my best adviser when it comes to my money. So is everyone else with their money. Libraries, bookstores and the internet have more than enough information to help the average person take control of their financial future.”
Really? Well why use CPAs, Lawyers, Doctors if you can find all that information out there. My example is extreme but you get the point.
Don’t let a bad experience send you the wrong way… just get yourself a good financial advisor.
The real advisor sees his payout through referrals/introductions and does not focus solely on commissions. If you are a good advisor you wouldn’t sell what is not suitable. Trust the commssions paid don’t go that far.
Harry Sit says
@aldo – “All in all, VUL work extremely well for certain people.” I can’t disagree with that. That number of certain people pales in comparison to the number of people who are sold VUL though. Marijuana has some medicinal use. It also works extremely well for certain people. But that’s not how the vast majority of it is used.
Max says
Now there is new type of life insurance called Index Universal life(IUL), would you like to provide some inputs in this subject too?
Harry Sit says
Max – Index Universal Life (IUL) is still a type of Variable Universal Life (VUL). Instead of using mutual funds in the sub-accounts, it uses Equity Index Annuity, which is worse than regular mutual funds in the long run. Equity Index Annuity is always pushed during a bear market. It gives you some downside protection in a bear market but it limits your upside in a bull market. Buying downside protection when substantial downside has already happened is exactly the wrong time to do it.
Index Universal Life is still VUL. It’s worse than regular VUL.
[Update on Jan. 8, 2010] See correction below.
Lory says
My husband and I purchased VUL’s as an investment vehicle. We didn’t put any money into them upfront except for our first premium fee’s. We pay our premiums monthly and have been slowly accumulating money. They are Ameriprise/Riversource VUL’s. I believe that our SC will be over after 10 years. If we want to save money overtime and also invest it I take it after reading the previous comments that this is a lousy vehicle! What would you suggest we do after out SC period is over?
anonymous says
Can someone tell me more about the Indexed Univeral Life? For example those of Life Insurance of the Southwest? Is this the best retirement and college funds savings for me and my family? What are the tax implications when I need to take the money out for my children’s education, say 10-15 years from now? I was looking to eliminate their 529 and stop my 401K contributions to participate in these policies. I have been informed that this is the best tax-free retirement income and college funds when the child is 18. After reading all these posting, I’m reconsidering what I’m about to do. Please advise.
Harry Sit says
@Lory – After the surrender charge period is over, you will have to see what the cash value is compared to your cost basis (get both numbers from Ameriprise). If your cash value is above your cost basis, you can just cash out. You will have to pay taxes on the gain. If your cash value is below your cost basis, you can do a “1035 exchange” to a low cost variable annuity that does not have a surrender charge, such as variable annuities offered by Vanguard. Let the market value catch up to your cost basis before you cash out from the variable annuity.
@anon – Indexed Universal Life is most likely NOT the best retirement and college funds savings for you and your family. Don’t just take my words for it. Also read this article by Money Magazine senior editor Walter Updegrave:
Investing in a pricey life insurance policy
William says
Indexed universal life insurance for college savings? My instinct says do not fall for it. The sales man will likely get a nice commission from the sale of this product. Don’t stop 401k contributions. Don’t you get an employer match for you contributions? And aren’t contributions tax deductible?You should be maxing that vehicle out. I’m not sure about 529s. You might qualify to contribute to a roth ira. Earnings from a roth are withdrawn tax free after 59 1/2. Principal can be withdrawn tax and penalty free at any time. The principal balance of a roth ira can be a good source of college funds, held in your name, for your children. Think about it. If you start when the child is 8, at $5000 a year, you will have $50,000 at your disposal,tax free, when the kid is ready for college. The earnings are yours, tax free, after 59 1/2. You may need other sources like a 529, but its a start. Stay away from insurance as an investment vehicle. I know from experience. Buy term life insurance. It is a good value these days. Insurance wrapped in investments can cost up to from 5x to 10x what a term policy of the same face value would cost. Educate yourself before you commit to this type of insurance policy.
GIAC in VB says
Hi everyone,
I am a seasoned insurance agent and investment advisor. I’ve worked with some high quality firms.
I feel like no one specific strategy is good or bad for everyone. That is why so many clients and advisors get in trouble! You can make blanket statements like ‘buy term and invest the difference’ or ‘all VUL policies are bad’ or trash variable annuities.
Please remember this, and this as the ONLY rule of thumb that applies: your strategy should be individually crafted based on your goals and aspirations. Just as you should not listen to an ‘advisor’ that cannot offer a wide variety of strategies amongst multiple top notch companies, you should not make assumptions about your own strategies that are in place based on some disgruntled web bloggers.
Go get a professional opinion. If you don’t know how to find a great advisor, ask for a referral from the most successful person you know! If no one you know has an advisor, begin the process by interviewing a number of agents/advisors at various firms, but do your homework first! Ask tough questions, and have them prepared in advance. Don’t sit passively through a ‘pitch’ and get duped and then blame an entire company!
Unfortunately, in this industry, I have learned that there are some really rotten apples and it ruins the reputation of entire firms!
Just don’t get too jaded. Be on your guard, but there are some good people happy to help you out there!
Darren says
I have had a $1 million dollar VUL policy for 4 years and currently have $10K in cash value. I have finally decided to do my own research and have come to the conclusion that a VUL is a TERRIBLE idea for the average investor/person. At this point the best action for me to take is to get term life insurance and stop funding the VUL. I would surrender today, but after the next year my surrender penalty starts to decrease up until year 10 when there is no surrender penalty. I am waiting to hear back from Ameriprise to see at what rate the surrender penalty decreases from year 5 to year 10. Once I know that rate I will have to balance the following factors to determine when is the best time to surrender: the rate at which the surrender penalty decreases, thus allowing my surrender value to be a higher percentage of my cash value; the monthly cost of insurance, how that increasing rate (10% year over year) will increase in proportion to the decreasing rate of the surrender penalty; and finally the expected return I have on my cash value and how that will cause the expected surrender value to increase over time.
So I estimate that at the latest will surrender after year 10 when there is no surrender penalty unless it is better for me to surrender early is the rate at which the surrender penalty decreases from years 5 to 10 and that rate is not great enough to free up current surrender penalty money that can be used to either pay monthly cost of insurance of better yet be returned to me when I surrender. (and I have not looked yet but I am assuming the surrender value is taxed so that would be the last factor to weigh into when I should surrender from now until after year 10)
Finally, one thing I was not made aware of when I purchased the policy was the rate at which the cost of insurance increases over time. I can only blame myself but I should have also been made aware of this by my Ameriprise Financial Adviser. The monthly cost of insurance increases 10% year over year!!! By the time I am 70 years old my monthly cost of insurance will be $7,000!!! Assuming my current monthly cost of insurance increased every year for inflation at a rate of 3%, my current inflation adjusted monthly cost of insurance at age 70 would only be $298. At that same age if I was paying $7000 a month for term life insurance my benefit would probably be $10 million compared to the $1 VUL policy. What a scam!!!
These should only be used as a tax shelter for the 0.1% of the richest people who would choose to have the smallest face value and would simply use this to let money grow tax free until they can withdraw the money with no tax-penalty.
Diane says
Ok – what is fustrating is everyone expects people to GIVE GIVE GIVE & TAKE TAKE TAKE – everyone has a job and should get paid what they are worth. You wouldn’t go to the supermarket and just snatch the food & leave would you? No, because there are costs and fees … sometimes, oh my gosh – hidden costs! Then there is coupons! WOW!! Now you can SAVE $$ on the additional costs.
I purchased a VUL in 2004. 1mil dealth benefit. BUT I also had a term that I purchased 5-years earlier (under $10 a month for a 30 years! and the company has switched so many times I can’t even tell you. I have been in danger of loosing this “average joe protection policy” each time they transfer it. (term is a $100k policy). I only had under $10k in the VUL and borrowed $5k to help me when I lost my job. I still have the policy and even though we put it on hold for TWO YEARS – it is still benefiting us!! This has been a great policy. I know I am protected, and I don’t expect agents to work for free, so they should get some sort of commission for educating me on more then I knew previous to them talking to me at all. I have referred others to this agent. When my husband & I talked about it we broke it down in terms of a mortgage on your life for lack of words. The market goes up & goes down. We still have a benefit on our lives & we know our wishes will be carried out – worst case, we can liquid the $ after the kids are in college and use it ourselves, still having piece of mind at a lower premium then when we are in our 60’s. We didn’t get a term because we didn’t want to “rent” we wanted to “stay” ….. There is something for everyone .. that is why we have choices, am I right???
Zak says
I’m sure all of these points were discussed in previous points, but I wanted to throw my 2 cents in. VUL’s (and permanent insurance in general) are neither inherently good or bad. They are just appropriate for certain situations.
It is correct that they have an upfront load for money on the way into the policy, like an A share of a mutual fund. They also have an M&E charge (typically drops off after 10 years). They also have a surrender charge (like vesting in a 401k… often 5-10 years) as well as the normal cost of insurance charges. They are not “light” on fees by an means. The other thing to keep in mind is that certain fees, such as M&E charges, are typically loaded into the first 10 years of the policy. So combine that with the surrender charge and a bad explanation from a financial advisor on how these thing work and of course you are going to feel jipped.
Now, one thing to take into account is that regardless of what you plow into the thing in terms of premium, the fees (aside from the upfront load) do not change. They are tied to the death benefit and not the premium. The way you make these things work is you over fund them…. and massively so. If you are plowing as much into it as the IRS will allow you, or at least close to this amount, the fees become a much lower ratio compared to the total premium. Consequently, if you DO get sold one by a shady insurance agent, he may have sold you the biggest death benefit he could, which means the policy is not being effectively overfunded it and your fees, as a ratio to the total premium being put into the policy, are quite high.
Ignoring for a moment the fact that there is any insurance benefit and analyzing it strictly from an investment standpoint, you are essentially being charged a fee to participate in a Roth IRA. Would you pay money to invest in a Roth IRA? You might if you were phased out of one. Chances are, if you are in a high enough tax bracket and funding it appropriately, the fees will be outweighed by the tax advantages.
Here are some basic rules of thumb to assist in deciding whether or not a VUL is right for you (from an investment standpoint only):
– You are in at least the 28% tax bracket (preferably 33 or 35%)
– You can afford to fund the policy close to guideline (the maximum set by IRS)
– IMPORTANT: You don’t plan on accessing the funds for at least 15 years, preferably 20-25. These are not short term investments. It takes time for the IRR to ratchet up.
Of course there are inherent insurance benefits to having permanent insurance, but most folks arguing VUL/Whole Life versus a term/invest the difference strategy are concerned with returns. And I hope I’ve made my point that it just depends on the right situation and an appropriate funding level. People that say they are the worst vehicles ever have a poor understanding of the product (and probably finance in general) and were probably sold an inappropriately large policy by their advisor. People who say they are the best product ever are probably in a higher tax bracket and have an ethical advisor who sold them an appropriately sized policy (and did a darn good job of explaining it).
Zak says
@TFB
I’m amazed how many people on these blogs don’t know anything about what they are talking about.
Regarding Indexed Universal Life:
No, they are not like equity indexed annuities (which can definitely be terrible products). Indexed Universal Life is a universal life product that has a crediting method which is typically pegged to the performance of the S&P 500. Overtime, has the S&P 500 been severely outperformed by wisely managed mutual funds? Absolutely. So is a policy that is tied to an indexed investment such as an IUL going to be better than an actively managed investment such as a VUL under this definition? Probably not.
The attractiveness of an IUL has nothing to do with the fact that it is indexed. It has to do with the fact that the insurance company offers a floor and ceiling to the investment returns. For example, you might find a product that offers an indexed return that is guaranteed not to return less than 2% in a given year. To offset this guarantee the insurance company will place a ceiling on the return as well, something probably around 14% or so.
Will the VUL outperform the IUL over a long time horizon? It very well might. But the IUL will grow with FAR less volatility, and that has inherent value in and of itself. Because cost of insurance charges are withdrawn from the cash value on a monthly basis, you are in essence reverse dollar cost averaging from the account, which makes volatility in permanent insurance plans potentially very dangerous. The IUL can offer a nice medium ground between VUL and Whole Life…. something that has growth potential (like a VUL) but lower volatility (like a Whole Life contract).
Equity indexed annuities….. please……
Harry Sit says
I stand corrected for my comment #32 entered on August 24, 2009. Index Universal Life (IUL) is NOT Variable Universal Life (VUL). An IUL does not use a separate account. There is no prospectus. The money invested in an IUL is in the general account of the insurance company. Although IUL crediting is similar to crediting in an Equity Indexed Annuity, there’s no direct relationship between the two products.
Technicalities aside, these don’t change the general conclusion about IUL. The downside protection remains the selling point of IULs. This protection is always emphasized when the downside already happened. The cost of the downside protection is the limit on the upside. Investors will likely pay a high cost for the downside protection.
The trick these days is to switch people from a poorly performed VUL to an IUL. The agent gets a new commission. The clock on the surrender charges starts over again.
Erik says
I am an advisor and have sold probably one VUL in the last two years, but it’s not because I think they’re not worthwhile. It has to be the right situation–the higher the client’s expected future marginal income tax better, the more it makes sense.
A skeptic by nature, when I got into this field I built a spreadsheet, and you can, too. It’s a little complex to explain every cell and formula, but in a nutshell, I assumed someone with, say, $10,000 of investable cash flow (after they’ve funded their 401(k), which they should do first). If he or she bought a large term life policy for, say, $1000 a year, and then invested the remaining $9000 annually in a non-qualified brokerage account, would he or she be better off or worse off taking that same $10,000 and dropping it into a VUL of the same size as the term policy?
The way to answer that mathematically is to (1) assign the same assumed gross annual rate of return to both the VUL and the nonqualified investment account, (2) subtract annual investment expenses expressed as a percentage, (3) recognize for annual taxation purposes on the nonqualified account a representative annual distribution of dividends, interest, and possibly short-term capital gains (e.g. in a mutual fund), (4) tax those gains, (5) reinvest the net after-tax distributions, (6) and repeat. Then, at the expiration year of the term policy, calculate the difference between the nonqualified account value and its cost basis, and then apply a long-term capital gains tax to that difference, subtracting that tax from the total. Also don’t forget to tax distributions in that final year. Compare the net to the cash value within the VUL as shown on the illustration. Since that cash value is a potentially tax-free, it is the relevant comparison.
Doing this, I have found that generally the VUL’s cash value at, say, year 30 is greater than the spendable net value of the nonqualified account. But I acknowledge that if one is a genuinely knowledgeable do-it-yourselfer investor and can thereby knowledgeably control both investment costs and annual taxes on the nonqualified account, the advantage tilts away from the VUL.
In reality, though, a much smaller percentage of individual investors actually achieve the returns they could in an account prudently managed by a professional. Some will. Maybe most of the posters on this site would. But again and again I see that their confidence proves to have been misplaced hubris. And in the absence of comparable returns to what the gross returns in the VUL would be, these investors are worse off by not being in the VUL.
The last consideration is this–if I’m in a 30-year term and it reaches the 30-year limit, but I needed a 40-year policy and am now uninsurable, it sure would be nice to have had some portion of my life insurance in a permanent form. And depending on my age when I began the policy, then the question is which permanent form makes the most sense. Oftentimes for younger or more aggressive clients, the VUL is a better choice than a UL or whole life policy.
Anyway, please try to build a fair spreadsheet that incorporates all the true costs of building a non-qualified (taxable) investment account, and compare that to a VUL illustration. In the out-years — which are the ones that generally matter most — see which has more spendable money. I think some of you will be pleasantly surprised.
JAKE says
Wow, it’s quite interesting to see where this discussion is headed. In light of people’s different view, allow me to add a different perspective to this entire theme: insurance & financial planning. First off, all products are designed for a market and every case is indeed different. One should evaluate their financial position both on the short term and long term basis. Second, it’s both the agent’s job and the consumer’s responsibility to do their due diligence. This means the consumer should ask questions and agents should do a good job explaining. The problem is that too many consumers lack the financial literacy/language and understanding while the agents, representing the insurance companies, too often than not are incentivize by the commission check.
Here’s the different option: buy a cheap term with large enough death benefit (more than you’ll need or the kids) and couple that with a Equity Index Universal Life (EIUL minimum only w/ cash value). You plot this on a graph and you have two products; 1) immediate death coverage (ie., $1M 30yr term) plus 2) long-term coverage without the scrutiny of having to screen at a later age (EIUL). Once your 30-year term drops out you’ll be in a position to have accumulated some cash value in your EIUL while at the same time save $$$ all along which can be better allocate towards other investments. Of course, this is under the assumption that you have time on your side and if you have kids they’d be well off into their adult years by now. Besides, what’s the whole point of having protections for? Oh, and for those who are really interested – I recommend you consider an Irrevocable Life Insurance Trust (ILIT) account. You get the better of both world.
JAKE says
Life insurance for retirement and college savings?
My take is that you should consider a 529 plan that will match some of your contributions (there’s a cap per child). If you’re interested, consider looking into MN 529 Plan for they have a very attractive plan to help you reach your savings goal for the kid’s college expenses. Or just run some research online and you’ll find the product that’s best suited for your kid’s needs.
Equity Index Universal Life Insurace (EILU), on the other hand, can potentially help to not only provide protection but retirement as well. For those who are not familiar with the product you can actually fund your retirement through a cash withdraw or monthly inflow of cash depending on how much you need to supplement retirement. You get both the insurance protection plus cash value built-in as well as the option to receive money at retirement. I think it’s a great product!
As a side note to my earlier posting about ILIT account you get to protect your estate when you die! Better yet, you get to use your Gift Tax allowance (if you have any to spare) and fund this account. Your kids get your estates without the burden of having to liquidate your assets to pay for the “dead” tax once you’re gone! Best of all, Gift Tax is exempt from being tax and this year’s limit has been raised to $13,000!
Zak says
Just to clarify on ILIT’s: Do keep in mind NOT to place a policy in an ILIT that has cash value that you plan on using. Once a policy is in an ILIT, it becomes irrevocable and the original owner can no longer have any “incidents of ownership”, which, among other things, means no access to cash value. This liquidity downside is countered by the fact that the proceeds from the policy are now removed from the estate and no longer subject to estate taxes.
The main thing to keep in mind is that ILIT’s are an estate planning tool and NOT a form of trust that should be mixed with policies which are geared for cash value accumulation. An ILIT policy should typically be structured for maximum death benefits and minimum cash value for your premium. Conversely, policies designed for retirement use should be typically (but not always) geared for minimum death benefit and maximum cash value accumulation.
I typically would use a 529 plan over a life insurance policy for educational funding, because the time horizon is too short to have the tax advantages of the life policy make any sense. The internal rate of return simply wont be able to get high enough. In addition, the cap on 529 plan contributions is $330,000 (yes, you’ll pay gift taxes over $13K), so there is little risk of “maxing it out”. The only reason I would use a life insurance policy for education would be if you really want permanent insurance as well. Of course 529 plan funds also have to be used for education if you dont want to be penalized.
The reason that this differs from retirement is that you (a) typically have a longer time horizon until retirement and have time for the IRR to build up and outweigh the insurance costs and (b) the cap on 401(k)’s is $16,500 annually (+$5K over age 50), which most appropriate users of permanent insurance will easily blow through and max out.
Just remember that this whole issue of permanent insurance versus more traditional investments is pretty complex to make any blanket statements about. It involves a complex analysis of your tax bracket, time horizon, liquidity concerns, estate size, and desire for permanent insurance coverage. But it is a topic well worth investigation and consideration. Just don’t follow the Suze Orman’s of the world like lemmings…. seek actual professional advice. 🙂
Mike says
What would you do for a child? I’m looking at setting up a VUL for my 8 year old and maxing it out without creating a MEC. I don’t know what tax bracket he will be in at retirement, but he will have 50+ years before he retires and this looks like a great option for him and affordable for me and also gives me a seperate life poilcy on him incase somthing happened.
I see the Gerber and other whole life products, but I think a more aggressive policy would be better in the long term for a child? Any thoughts?
He is to young for term and has no income to set up a Roth IRA.
Zak says
Mike,
I think this could be a good idea, but I would only do it if you want him to use it later in life (and NOT for education as the time window is just too short). I would personally agree on the VUL over Whole Life in someone that young’s case, but that is more up to you and your personal risk tolerance.
Your other option would be an UGMA/UTMA as that will shift money to him in a manner that is irrevocable and move it (except for amounts where it would generate a certain amount of passive income and trigger the “kiddie tax”) out of your tax bracket and into his. You could also set up an inter-vivos irrevocable trust.
It all depends on what your goals are for the money. But based on the basic info you provided, I think a VUL would be an intelligent option and one that would not require the use of an attorney (such as the trust would). I would consult a local financial advisor in your area that is fully independent (as in they are not purely life insurance or equities focused).
HNW Male says
@ TFB
Several have said that the VUL could be a fit for a very small number. What does the ideal VUL candidate look like? I need tax deferral. We max out 401k, do some deferred comp, etc. My plan is to max fund a VUL (without creating a MEC.) The only thing I may consider is a 529 but I could do both. I am 37 with 1st child on the way. My adviser says that I am “ideal”. Thoughts?
SmartMoneyGuy says
I’ve been an advisor for 35 years, and I’ve sold it all. At this stage of my career, most of my clients are growing older too. The last 10 or 12 year period is a perfect lesson in managing risk. VUL can have it’s place… I’ve sold some over the years, but in the market crash of 2000 / 2002 when the market dropped 48%, many of my clients were hurt. (That’s when I quit selling it) Obviously recovery takes place, but who wants to waste 7 years making up for a 50% drop in value. Fast forward to 2007 / 2009. Here we witnessed a whopping 58% decline in the overall market. Think there might be some desire for a product or a strategy that limits or eliminates downside risk? You bet there is, especially if you are 50 or older and don’t really want to spend the next ten years climbing out of a hole.
To say that Index Annuities or Index Life is a bad plan because they limit the upside is a poor argument. The really ‘poor’ strategy is investing in Mutual Funds, Variable Annuities, or VUL and watching helplessly as 50% of your nest egg goes up in smoke, while paying fees whether you’re account value is headed up or down.
Wharton School of Finance recently did an unbiased, university level study of various investment vehicles over a 15 year period, including the S&P500 versus Index Annuities. Son of a gun if the old, boring, ‘high-fee’ Index Annuity didn’t beat everything else! These products have brought returns averaging 6 to 9% over the past 16 years.
You can’t get around the fact that bear markets (20% losses or greater) appear every 6 or 8 years, where losses average 39% and 5.2 years (on average) is spent in recovery. Avoiding the losses is much more important than chasing the home runs. Just ask Warren Buffet.
Buy the overall market. Limit your risk by using a tool such as Index Annuities, or Index Universal Life (if you can buy it early enough) and you will do just fine. Enjoy some tax advantages and sleep better every night.