Variable Universal Life (VUL) insurance is one of the most complex financial products available in Canada. It combines a permanent coverage and a self-directed investment component with the potential for significant tax-deferred growth. However, VUL also comes with considerable risk and complexity, making it suitable for only a small segment of the population.
What is Variable Universal Life Insurance?
Variable universal life insurance is a form of permanent life insurance intended to provide lifetime protection. As with other permanent policies, variable life insurance has two primary components:
- Death benefit: The amount payable to your beneficiaries if you pass away while the policy is active. The death benefit does not decrease as you age.
- Cash value: A savings and investment component within the policy. A portion of your premiums funds this account, which can grow over time.
The “variable” in VUL is the crucial differentiator. This policy allows you, the policyholder, to invest the cash value in a selection of investment funds, similar to mutual funds. These sub-accounts can hold stocks, bonds, and other securities.
As investments fluctuate in value, your cash value account also rises and falls with their performance. You assume all the investment risk. This contrasts with whole life insurance, which guarantees a minimum return on the accumulated cash value.
How VUL Insurance Works: A Practical Example
With a variable universal life insurance policy, a portion of each premium is allocated to the cost of insurance and related administrative expenses, as determined by the insurer. The remainder gets invested into the accounts you select.
You have the flexibility to adjust your premium payments within limits defined by the insurance company. Paying more allows faster potential cash value growth, while lowering premiums decreases those gains.
You also control how your cash value gets invested. Most VUL policies provide access to an extensive suite of investment account options. These are typically structured similarly to mutual funds, covering assets like:
- Canadian and global equity funds
- Government and corporate bond funds
- Money market and fixed-income funds
- Index funds
- Sector-specific funds
For example, assume you pay a $5,000 annual premium into a VUL policy. Here’s how that money is allocated:
- Cost of Insurance (COI) & Fees: The insurer first deducts the cost of providing the death benefit, along with policy administration fees. Let’s say this amounts to $1,000 for the year.
- Investment Deposit: The remaining $4,000 is deposited into your cash value account.
- Your Investment Choice: You then direct that $4,000 into various sub-accounts offered by the insurer. For example, you might allocate 60% to a Canadian Equity fund, 30% to a U.S. Index fund, and 10% to a Bond fund.
As your selected funds fluctuate with market performance, your cash value balance will change as well. During bull markets, your investments can grow substantially. However, your cash value could decline during market downturns or if you invest in poorly performing investments.
- If your chosen funds perform well (e.g., a 10% return), your $4,000 grows to $4,400 (minus investment management expenses, or MERs).
- If your chosen funds perform poorly (e.g., a -15% return), your $4,000 shrinks to $3,400.
If the balance drops too low, you may need to increase premiums to keep the VUL policy active. Otherwise, it could lapse if the COI exceeds the available cash value.
Pros and Cons of Variable Universal Life Insurance in Canada
Variable universal life insurance offers unique benefits but also has some clear drawbacks:
Pros
- Lifetime insurance protection
- Flexibility to adjust premium payments
- Control over investing your cash value
- Potential to earn higher returns than whole life insurance
- Tax-deferred growth on cash value
Cons
- More expensive premiums than term life insurance or whole life insurance
- Risk of investment losses shrinking your cash value
- Ongoing monitoring and management required
- The complexity of managing numerous investment accounts
- Potential fees and restrictions imposed on transactions
The advantages depend largely on your investment experience and ability to actively manage your VUL policy. It also requires having adequate time to handle the added complexity compared to term or whole life insurance.
Who Is Best Suited for Variable Universal Life Insurance?
Given the higher costs and need for investment expertise, VUL insurance is likely only suitable for a narrow subset of consumers:
- High net worth individuals – The premiums may be manageable for those with ample disposable income. VUL also helps transfer wealth tax-efficiently.
- Savvy investors – Investors comfortable managing portfolio risks may appreciate selecting VUL cash value allocations.
- Maxed registered accounts – Once RRSP and TFSA limits are reached, VUL can offer tax-deferred growth potential.
However, VUL is often not the optimal choice for average Canadians simply seeking sound life insurance. Term life insurance will provide sufficient, affordable coverage for most households.
Permanent protection options like whole life insurance also guarantee principal and returns without the risks of VUL investing.
Variable Universal Life vs. Whole Life Insurance: A Detailed Comparison
Whole life insurance and variable universal life insurance policies are both forms of permanent life insurance. However, they differ notably in their cost structures, cash value features, and overall complexity.
| Factor | Variable Universal Life | Whole Life |
|---|---|---|
| Premiums | Can be adjustable within limits set by the insurer | Fixed premium payments |
| Cash value return | Variable based on the performance of invested funds | Fixed rate of return guaranteed by insurer |
| Risk tolerance | Higher to accept the volatility of the cash value | Lower with guaranteed cash value growth |
| Management needs | Requires ongoing monitoring and fund rebalancing | Minimal once the policy is in force |
| Fees | Generally higher with insurance fees + fund management expenses | Lower without investment fees |
| Withdrawals | Access cash value at any time | Limited availability specified by insurer |
| Policy lapse risk | Higher if market losses deplete cash value | Lower with guaranteed cash value |
| Tax benefits | Tax-deferred growth on cash value | Lower cash value accumulation provides fewer tax benefits |
| Suitable buyers | Experienced investors comfortable with risk | Average consumers wanting simple permanent coverage |
The main appeal of VUL is the opportunity for higher cash value growth compared to whole life. However, this comes with the trade-off of higher fees, investment risk, and time required for management.
Guaranteed whole life policies offer fewer risks and less complexity for most Canadians needing permanent life insurance protection.
If you think VUL Insurance is the right choice for you, here are some key considerations:
- Total premium cost – Project whether total lifetime premiums will be affordable to maintain the policy.
- Insurer financial strength – Choose only insurers rated very strong for supporting lifelong obligations.
- Investment skill – Realistically assess your experience with portfolio management and risk tolerance.
- Policy complexity – Understand the time obligation to actively monitor and manage your VUL.
- Cash growth expectations – Model projections, but be wary of illustrated optimistic returns.
- Policy lapse risk – Avoid potential lapse that would forfeit coverage after years of premiums paid.
- Quality advisor – Work with a top independent broker who offers unbiased guidance.
Take great care in evaluating these factors. Misalignment with your needs on any one of them can make VUL insurance ultimately unsuitable despite the unique benefits.
Variable Universal Life Insurance Products Available in Canada
Most prominent life insurance providers in Canada offer some version of a variable universal life insurance policy. Here are some examples of VUL products in the Canadian market:
Sun Life – Sun Universal Life II: Known for a wide range of over 50 investment options.
- Investment fund options covering stocks, bonds, and money market
- Additional insurance riders are available
- No-lapse guarantee ensures death benefits up to age 100
RBC Insurance – RBC Growth Insurance (VUL): Offers a curated list of funds, including index and ESG options.
- Over 25 fund choices, including index funds and ESG options
- Guaranteed insurability rider to increase coverage
- Option for partial withdrawal from the cash value account
ivari – Infinite Universal Life: Features loyalty bonuses that can reduce costs for long-term policyholders.
- Over 30 fund choices across major asset classes
- Minimum death benefit guarantee of the original face amount
Equitable Life – Pivotal Select: Offers a broad selection of funds from third-party managers.
- Over 45 fund options from leading investment managers
- Can hold cash value inside account earning interest
- Lifetime benefit guarantee up to age 100
The available investment funds within VUL policies generally cover all major asset classes. Most insurers partner with established third-party fund managers to provide diversified options and professional administration.
Critical Tax Considerations for VUL Policies
The tax treatment of VUL policies is complex and has changed significantly.
- Premiums: Not tax-deductible.
- Death Benefit: Paid to beneficiaries completely tax-free.
- Cash Value Growth: Grows on a tax-deferred basis.
- Withdrawals & Loans: You can access the cash value tax-free up to the policy’s Adjusted Cost Basis (ACB). The ACB is essentially the total premiums you’ve paid minus the net cost of pure insurance. Withdrawals or loans exceeding the ACB are taxable.
s VUL Insurance Subject to Part XII.2 Passive Investment Rules? For policies issued after 2016, these rules can have a major impact. In simple terms, if the cash value of a policy becomes very large relative to its death benefit, a portion of the annual investment gains inside the policy may become taxable each year, even if you don’t withdraw any money. This erodes some of the tax-deferral advantage for very large policies. (source: Income Tax Act (R.S.C., 1985, c. 1 (5th Supp.)))
Crucially, you must consult with a qualified tax professional and an insurance advisor to structure a VUL policy in a tax-efficient manner.
FAQs on Variable Universal Life Insurance
Can you lose money with VUL insurance?
Yes. You can lose the principal in your cash value account if your chosen investments perform poorly. This is the primary risk of a VUL policy.
Can variable universal life insurance expire or lapse?
Yes, VUL policies can lapse if the cash value falls below the required minimum to cover the insurance charges. Poor investment performance or withdrawals that exceed the cash value can create a shortage, leading to lapse.
Does VUL require a medical exam?
Yes, in nearly all cases. Applicants must undergo a medical exam for the insurer to assess their risk profile and determine the cost of insurance.
Do VUL premiums change?
VUL is a type of permanent life insurance where the policyholder invests the cash value in market-based sub-accounts, assuming all the investment risk for potential higher returns.
The Bottom Line
Variable universal life insurance offers flexibility and the potential for market-based cash value growth that can outpace that of whole life insurance. However, VUL is also much more complex, with notable risks that make it inappropriate for many consumers.
For most Canadians simply seeking permanent life insurance protection, term or whole life policies are likely better choices. However, a subset of experienced investors willing to take on risk may benefit from VUL’s unique attributes and investment features.
Thoroughly analyze your insurance needs, investment acumen, and risk tolerance when considering VUL. Doing so helps ensure you select optimized coverage that aligns with your financial priorities now and throughout life’s changes.
