NYLIAC Variable Universal Life 2000
NYLIAC Single Premium Variable Universal Life
NYLIAC Variable Universal Life Provider
"Buy term and invest the difference?"
"Buy term and invest the difference" is one of the most prevalent strategies
consumers encounter when shopping for insurance. This approach involves
purchasing lower cost term insurance (when compared to forms of permanent
insurance) and investing the difference in growth-oriented products, such as
stocks and mutual funds. For some, this makes sense, especially if the need for
protection exists and you are on a tight budget.
Times have changed. Today, the insurance industry offers much more than just
whole life and term insurance. One such product to arrive on the scene in recent
years is variable universal life insurance (VUL). Variable universal life insurance combines permanent
insurance protection with investment flexibility.
For the purpose of this discussion, we will examine VUL and see how it compares
to the traditional "buy term and invest the difference" philosophy.
Permanent Protection and Much More
VUL offers permanent insurance protection, usually through age 95. Simply put,
this means that as long as you meet the policy costs, you are guaranteed
protection. Some term insurance products periodically require proof of
insurability to continue coverage. While there are term products that can cover
you for life without additional requirements, their rising costs can make them
prohibitive.
Additionally, while all term insurance is purchased with after-tax dollars, VUL
has the potential to satisfy its policy costs with pre-tax dollars (policy's
cash value accumulates on a tax-deferred basis), further strengthening the VUL
strategy.
At first look, term insurance may seem attractive because you can purchase large
amounts of coverage at a relatively inexpensive price. But, the cost should not
be the only consideration that goes into your decision making process. For
instance, consider the impact of becoming uninsurable at the
end of the term period due to a health condition. You may save a few dollars
today, but the eventual cost of uninsurability may be the death benefit your
beneficiaries will never receive.
Permanent protection also offers a host of policy riders that can further
enhance the effectiveness of your policy. Term insurance provides a much more
limited range of riders.
Cash Value Accumulation
You can also allocate a portion of each VUL premium to one or several investment
divisions, or a fixed-rate general account option. These investment divisions
typically include stock, bond, balanced, international, and money-market
portfolios. Earnings within the investment divisions will vary with market
conditions and your principal may be at risk. Premium payments plus investment
earnings, less policy fees and charges, serve as your policy's cash value.
Usually, you can allocate as little as 1% of the premium to any of the
investment divisions in a VUL policy. It should be noted that a decrease in your
policy's cash value may decrease the overall amount of insurance coverage.
Term insurance has no cash value. You do have the option of "investing the
difference" in growth-oriented products, like mutual funds. The value of your
mutual fund account will vary with market conditions. Your principal may be at
risk and, in most instances, mutual fund earnings are taxable each year. This
means that you have less money working towards achieving long term goals. Most
mutual funds also require a minimum dollar amount to participate in a particular
portfolio.
Investing in vehicles like mutual funds is still a solid strategy to follow. But
you have to have the discipline to carry this out. If you neglect to put money
aside for the future, the "buy term and invest the difference" strategy
collapses. Without the 'invest' portion, you are left with a term policy that is
incapable of accumulating funds for the future.
Meeting Today's Changing Needs
Should your insurance needs change over time, VUL usually provides the
flexibility to increase or decrease your amount of coverage. 1 You can also make a lump-sum
payment to increase the policy's cash value. (The maximum lump-sum payment is
subject to IRS limitations.) And, should an emergency arise and you are short on
cash, you may be able to skip a scheduled payment and let the accumulated cash
value cover the policy's expenses. Keep in mind that the cost of insurance and
administrative expenses are still incurred.
1 To increase coverage,
you may need to provide satisfaction evidence of insurability or meet
other applicable underwriting requirements.
With term insurance, the cost for protection is lower. However, you cannot
change the policy's face amount and must meet every scheduled premium payment or
risk losing the insurance protection.
As your insurance needs change, it is quite probable so will your long-term
investment goals and risk-tolerance levels. With VUL, you have flexibility to
transfer funds between the investment divisions, tax free.2 So, you have the freedom to
make decisions based on your needs and not on the tax ramifications.
2 Many VUL policies restrict transfers from a fixed account to the investment divisions.
Tax Issues
Previously, it was noted that the earnings in VUL's investment divisions
accumulate on a tax-deferred basis. By deferring current income taxes, your
money benefits from the power of compounding. Most VUL policies permit
policyowners to access almost all of the cash value via a policy loan provision.
Usually, policy loans are tax free, but the overall amount of insurance coverage
may decrease due to any outstanding loan balance.
Mutual funds are more liquid investments. There are no loan privileges
and withdrawals of earnings may be subject to deferred sales and current
income taxes. VUL policies may also charge a surrender charge for withdrawals.
In addition, the tax treatment given to funds in a VUL policy is on a first-in,
first-out (FIFO) basis. This is advantageous should you wish to create a stream
of income at retirement. One potential option involves receiving withdrawals
until reaching your cost basis, then changing the method of withdrawals to
policy loans. Partial withdrawals are at net asset value, which may be more or
less than the original price. Withdrawals may be taxable and, if under age 59½,
may be subject to a tax penalty. Assuming the policy has been in force for at
least fifteen years and remains in force through death or maturity, this
arrangement would avoid a taxable event on the funds withdrawn4. Remember that
policy loans on withdrawals will reduce the policy's cash value and death
benefit.3
3 Partial withdrawals are at
net asset value, which may be more or less than the original price.
Withdrawals may be taxable and, if under age 59 1/2, may be subject to
a tax penalty.
4 Upon surrender, a taxable gain will be recognized, however, to the extent the outstanding loan basis exceeds the policy's basis.
The tax treatment given to dollars in a mutual fund is on a last-in, first-out
(LIFO) basis. This places mutual fund owners at a distinct disadvantage when
trying to access account values.
Death Benefit Proceeds
Protecting loved ones is one of the fundamental reasons for purchasing any type
of insurance. Both VUL and term insurance policies offer a death benefit. And,
both policies can be structured so your beneficiaries receive the proceeds
estate and income tax free. Keep in mind that any portion of the 'invest'
component not used in one's lifetime may be subject to both estate and income
taxes. As a result, your beneficiaries may receive a lesser amount than
originally anticipated.
Other Issues to Keep In Mind
In addition to the above comparisons, keep the following points in mind:
- You can use VUL's cash value as collateral when applying for a bank loan.
This does not hold true for term insurance, as it does not have a cash value
component.
- Generally, creditors cannot reach a permanent life insurance policy's cash
value. This does not hold true for mutual funds.
- VUL's death benefit (which may include tax deferred accumulations) is free
from probate. This does not hold true for mutual funds.
Make an Informed Decision
For some, the "buy term and invest the difference" philosophy is appropriate.
For others, the flexibility and control of VUL may prove to be an attractive
alternative. The key is to fully research both strategies and make a decision
that best suits your needs.
VUL policies are sold by prospectus only. Investors are asked to
consider the investment objectives, risks, and charges and expenses of
the investment carefully before investing. Both the product prospectus
and the underlying fund prospectuses contain this and other information
about the product and underlying investment options. You should read
the prospectuses carefully before investing.
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