It’s Time to Take a Fresh Look at VUL

by Josh Durand

The retirement landscape is undergoing dramatic change. Traditional pensions are becoming a rarity. In addition, it’s uncertain whether it will be possible to continue sustaining the current level of Social Security benefits. As a result, Baby Boomers and the generations that follow must be increasingly self-reliant about funding their retirement.

The insurance industry must focus on developing products that can mitigate risk while maximizing potential returns. Life insurance has traditionally formed a solid foundation for retirement planning by protecting a family’s financial future and helping offset the financial devastation of an untimely death. This is done through its income tax-free death benefit protection.

When it was created, variable universal life (VUL) insurance was a step forward in the evolution of life insurance. It offered a more flexible and growth-oriented solution while addressing permanent life insurance needs.

VUL products now include better death benefit guarantees and no-lapse guarantees as a central benefit or a rider benefit offered on existing products. VUL can also provide supplemental retirement income to supplement a 401(k) or IRA plan along with Social Security. This is due to two things:
1. VUL can allocate premium payments to equity sub-accounts. Equities have been shown to be the best asset class for return on investment.
2. VUL has the tax advantages of building potential cash value (tax-deferred), withdrawing money without incurring taxes (up to basis), after which additional income can be taken through loans.
VUL insurance typically offers a choice of three death benefit options:
1. Initially, the death benefit equals the specified amount. As the cash value grows, the death benefit will increase if the cash value (multiplied by a corridor factor) (from IRC 7702) exceeds the specified amount.
2. The death benefit fluctuates over time along with the cash value. Each year, the client purchases a consistent amount of pure life insurance protection.
3. The death benefit increases over time based on the initial coverage amount and premiums paid into the policy.

The market demand for guarantees remains strong. Innovative companies are evaluating the merits of offering living benefit guarantees within VUL products. When using a guaranteed minimum income benefit (GMIB), living benefit guarantees hold great potential for leveraging tax-deferred accumulation within the VUL policy into potentially tax-free supplemental retirement income. Offering a guaranteed minimum income benefit can also alleviate a client’s concern about market volatility.
The flexible funding helps Baby Boomers focus on generating cash values for asset accumulation. In the early years of a policy, it can be a good strategy to pay higher premiums than what is expected to be necessary over the long run. This builds a reserve (the cash value) that helps pay the rising cost of insuring an aging life. It also creates a hedge against lower than expected investment returns or higher than expected insurance charges.

Any kind of life insurance can provide protection, but VUL gives clients control over asset allocation. Asset allocation models are an industry standard on variable products. This structure diversifies account balances to help even out overall returns. It offsets prolonged market downturns while offering the potential to capitalize on market upswings.

The major part of each premium payment is invested in a wide range of diversified investment options. A portion is used to reimburse the insurer for policy and ex-pense charges as well as state and local premium taxes. Under existing tax laws, clients can generally move money among a VUL policy’s variable investment options free of current taxation. Clients can also skip premium payments, stop them, increase them, or decrease them as long as the required minimum premium is paid to keep the policy in force. Some clients choose to pay very high premiums in the policy’s early years to maximize the cash value potential. They may eventually need to reduce or stop premium payments to retain favorable life insurance status (depending on current law).

Using the accumulated cash value, clients can receive supplemental retirement income for as long as they need. Clients can also draw upon cash values for income planning in business situations. However, loans and withdrawals could affect guarantees, they could have tax consequences, and they could cause the policy to lapse because they reduce the policy’s account value and death benefit.
Let’s examine how a VUL policy can work for a typical client. Forty-five year old John Smith qualifies for Preferred Non-Smoker status. He needs a $1 million face policy with Death Benefit Option 1 (Level). John could take $67,530 in annual supplemental retirement income for the next 20 years starting at age 65. This assumes an 8% (net 7.24%) gross rate of return of with a maximum premium payment for 20 years ($20,080). Initially, withdrawals would be taken from the basis and then switch to loans. The policy would have $100,000 in cash value at maturity (age 100).

When structured appropriately, VUL policies offer the following tax advantages that other options don’t provide:

1. A tax-deferred asset growth potential with tax-free rebalancing.
2. Income tax-free access to cash accumulation through distributions.
3. An income tax-free death benefit.
4. Flexibility with premium limits.
5. No tax penalties for taking withdrawals before age 59 ½.
6. No forced income requirements at age 70½.

The VUL policy has a distinctive combination of protection, premium payment flexibility, tax-advantaged growth potential, and guarantees. This combination can help clients achieve long-term investment goals through continued market participation while ensuring that coverage will last through all market cycles. Now’s the time to take a fresh look at the unique advantages that a VUL.

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Josh Durand, FSA, MAAA is assistant VP, Vari-able Life Product Management within the Individual Markets Division of Lincoln Financial Group. His responsibilities include product design, pricing, and rate management for variable life products targeted for individual markets. Josh has more than 13 years of insurance industry experience in product development and pricing. Lincoln Financial Group is the marketing name for Lincoln National Corporation and its affiliates.