Astute investors needed for this insurance policy

An interesting form of life insurance that's grown in popularity is variable universal life insurance, a form of life insurance that adds additional investment features and control to the basic characteristics of universal life insurance.

Universal life insurance is permanent life insurance that includes both pure insurance and investment components, much like whole life insurance. However, universal life insurance allows the holder to adjust the amount of premiums that are paid, so long as they're sufficient to pay the cost of insurance. If a policyholder pays more than the amount required to cover the policy's insurance costs, the insurance company invests the excess.

The rate of return on these investments is based on the results of the insurance company's general asset account, and the policy owner does not have a say in what types of investments are made.

An owner of a variable universal life insurance policy can determine the types of investments that are made with a policy's cash value or investment account, and the account grows according to the returns on those investments.

The insurance offers the most flexibility in meeting your insurance needs and provides you with control over a policy's cash value/investment account through a choice of tax-deferred options.

You can invest in money markets, stock funds and bond funds. For some individuals, a variable universal life insurance policy is a way to trade mutual funds without owing taxes. That's because all exchanges made within a variable universal life insurance policy are tax-free. Ditto for the buildup in the value of the policy's cash/investment account. You can borrow or make withdrawals against this account or stipulate that the account's value be added to the face amount of the policy, thereby providing a greater death benefit to your beneficiary. It does however, require you to devote time to manage the policy's investment account. The policy's success or failure depends on the investment decisions you make.

According to Dennis Filangeri, a certified financial planner in Metairie, La., (dmfilangeri@home.com), variable universal life insurance "combines the best of all worlds, but at a price." Filangeri notes that many individuals lack the investment expertise to properly manage investment accounts in these policies and can fritter away its value. On the positive side, Filangeri says that many policies offer the policy owner enough investment options to enable the owner to construct a diversified investment portfolio.

Another positive feature of a variable universal life insurance policy is that the owner can borrow from the policy's cash value account for such needs as college tuition or purchasing a home. Because a policy's income is tax-deferred until it is withdrawn, a variable universal life insurance policy can be used as a vehicle for accumulating cash for a variety of purposes.

Moreover, if the money that's accumulated is borrowed instead of withdrawn, there's no tax to pay. The interest on the loan is deducted from the policy's cash value account. The interest charged by insurance companies, notes Filangeri, is relatively modest, between .75 percent and 1.5 percent. That's because the insurance company has virtually no risk; your loan is secured by the cash value of your policy. The Internal Revenue Service won't allow you to place an indefinite amount of money into these policies; it limits the amount you can contribute each year. The amount depends on the face amount of the insurance policy, and the insurer will tell you what that amount is. Filangeri said that because the insurance company has certain fixed expenses associated with issuing and administering a variable universal life insurance policy, your unit cost for the benefits/features that come with such a policy declines if you contribute the maximum amount permitted by law.

If your investment decisions work out, they can pay for the cost of your insurance. If they don't, however, you can find yourself in a situation where unless you come up with a substantial sum, your insurance policy will be terminated. In that event, not only do you lose your insurance protection, but any borrowing becomes taxable.

The bottom line is that a variable universal life insurance policy is best used by someone who is adept at making investment decisions and has adequate insurance protection through another policy.