For most people, a variable universal life (VUL) policy is not a good investment. The layered fees eat into returns so significantly that you’d almost always come out ahead buying cheap term life insurance and investing the difference in a low-cost brokerage account. VUL can make sense in narrow circumstances, typically for high earners who have already maxed out every other tax-advantaged account, but those situations are the exception rather than the rule.
How VUL Works
A VUL policy combines a death benefit with an investment account. You pay premiums, and after the insurance company takes its cut for fees and the cost of insurance, the remainder goes into subaccounts that work like mutual funds. You choose how to allocate among stock, bond, and money market options. The cash value grows or shrinks based on market performance, and you can adjust your premiums and death benefit within limits.
The investment growth inside the policy is tax-deferred, meaning you don’t pay capital gains taxes each year. You can also borrow against your cash value without triggering a taxable event, as long as the policy stays in force. When you die, the death benefit passes to your beneficiaries income-tax-free. These tax advantages are the main selling point of VUL as an investment vehicle.
The Fee Problem
VUL policies carry a stack of fees that you won’t find in a regular brokerage account. Understanding these costs is critical because they directly reduce how much of your money actually gets invested.
- Sales fees on premiums: A percentage of every premium payment is skimmed off the top before anything gets invested. This means if you put in $1,000, some portion never reaches your subaccounts.
- Mortality and expense (M&E) risk fees: An ongoing annual charge, calculated as a percentage of your account value, that compensates the insurer for the risk of paying out claims.
- Cost of insurance: A separate ongoing charge for the death benefit itself. This fee rises as you age, which means the drag on your returns gets worse over time.
- Administration fees: Either a flat fee or a percentage of account value charged for recordkeeping and policy maintenance.
- Underlying fund expenses: The mutual fund subaccounts have their own expense ratios, just like any mutual fund, layered on top of all the other charges.
- Surrender charges: If you cancel the policy or make withdrawals in the early years, you’ll pay a penalty. Surrender charge periods often last 10 to 15 years.
- Transaction fees: Some policies charge for transfers between subaccounts, partial withdrawals, or changes to your death benefit.
When you add all of these together, the total annual cost can easily reach 2% to 3% of your account value or more. In a standard index fund, you might pay 0.03% to 0.10% per year. That difference compounds dramatically over decades.
How VUL Compares to Buying Term and Investing
The classic alternative to VUL is “buy term and invest the difference.” You purchase inexpensive term life insurance to cover your death benefit need, then invest what you would have paid in VUL premiums into a regular brokerage account.
Actuarial modeling illustrates the math clearly. One analysis compared a 35-year-old male putting $14,201 per year into a permanent life insurance policy against the same person spending $635 per year on term coverage and investing the remaining $13,566. The term insurance provided $1 million in coverage for 20 years and $500,000 for years 21 through 30, covering the period when a death benefit was actually needed.
The breakeven gross return for the side fund, meaning the return needed to match the permanent policy’s outcome at life expectancy, ranged from about 4.3% to 8.1% depending on the investor’s tax rate and whether they used low-cost index funds or a managed account. At a 20% tax rate with a DIY index fund approach (0.10% in expenses), the breakeven was only 5.4% gross. The long-run average return of a diversified stock portfolio has historically exceeded that by a comfortable margin. In other words, most investors doing the term-and-invest approach would end up with more money.
That analysis used whole life rather than VUL, and whole life policies generally have lower internal costs than VUL. The breakeven hurdle for VUL would likely be even easier to clear with the term-and-invest strategy.
The Tax Advantage Is Real but Overstated
VUL’s tax benefits are genuine. Your cash value grows without annual capital gains taxes, policy loans aren’t taxable events, and the death benefit is income-tax-free. But those benefits don’t exist in a vacuum. You’re paying a heavy premium in fees to access them.
Before using a VUL for tax-advantaged growth, consider whether you’ve maxed out your 401(k), IRA, HSA, and any other tax-advantaged accounts available to you. These accounts offer similar or better tax treatment with far lower fees. A Roth IRA, for example, provides tax-free growth and tax-free withdrawals in retirement with annual expenses that can be as low as a few basis points if you use index funds.
There’s also a structural risk to the tax benefit. If your VUL policy lapses because market losses erode the cash value below what’s needed to cover insurance costs, any gains become taxable as ordinary income. Under Section 7702 of the tax code, a policy that fails to meet certain tests loses its life insurance tax status entirely, and all growth gets taxed as ordinary income in the year of failure.
The Risk of Policy Lapse
Unlike a brokerage account, where a market downturn simply reduces your balance, a VUL policy can actually collapse. Your cash value must remain high enough to cover the cost of insurance and monthly administrative charges. If a market decline drains your cash value below that threshold, you’ll need to inject additional premium payments to keep the policy alive.
This creates a worst-case scenario: a prolonged bear market hits, your cash value drops, the insurer demands higher premiums, and you either pay up or lose the policy. If the policy lapses, you lose the death benefit, you owe taxes on any gains, and you’ve already paid years of insurance charges you can never recover. Some insurers offer a no-lapse guarantee rider that prevents this, but it adds yet another fee to the pile.
When VUL Might Make Sense
VUL occupies a narrow lane. It can be a reasonable tool for people who meet all of the following criteria:
- High income: You’ve already maxed out your 401(k), IRA, HSA, and any backdoor Roth strategies, and you’re looking for additional tax-sheltered growth.
- Permanent insurance need: You have a genuine, lifelong need for a death benefit, typically for estate planning purposes such as covering estate taxes or equalizing inheritances.
- Long time horizon: You plan to hold the policy for 20 years or more, which gives the tax-deferred growth time to potentially overcome the fee drag.
- Financial stability: You can comfortably fund the premiums even during market downturns without financial strain, so you’re not at risk of involuntary lapse.
If you don’t check every one of those boxes, a combination of term life insurance and low-cost index funds in a brokerage account will almost certainly serve you better. The fees inside VUL are simply too high to justify for someone who can access cheaper alternatives for both life insurance and investing.
What to Look at if You’re Considering VUL
If you do fall into that narrow group, request a full policy illustration from the insurer showing all fees broken out individually. Pay close attention to the surrender charge period and how long your money would be locked in. Compare the total annual cost, including M&E charges, cost of insurance, administration fees, and underlying fund expenses, against what you’d pay for term insurance plus a brokerage account. Run the numbers at both optimistic and pessimistic market return assumptions, because VUL illustrations often show best-case scenarios that may not materialize.
Also check whether the policy offers a no-lapse guarantee rider and what it costs. Without one, you’re accepting the risk that poor market performance could force you to either increase your premiums or lose the policy entirely, along with any accumulated tax benefits.