What Is Variable Life Insurance

What Is Variable Life Insurance?

Variable life insurance is a type of permanent life insurance that provides a death benefit as well as the ability to build cash value through manageable investment options. Although this policy is riskier than other cash-value policies, it has the potential for higher returns.

If you're looking for life insurance with investment features, keep reading to learn about the fundamentals of a variable life policy and how it works.

What Is Variable Life Insurance?

Because variable life insurance is a type of permanent life insurance, it covers you for the rest of your life as long as you pay the premiums and keep the policy in good standing.

Variable life insurance is a type of cash-value life insurance that, in addition to providing a death benefit, also serves as a savings or investment vehicle, allowing you to access funds from the policy as needed (via loans or withdrawals) throughout your life. The main distinction between variable life insurance and other types of cash-value life insurance is that you can invest your cash value in a portfolio of securities.

Managed mutual funds, stocks, bonds, and fixed accounts are common investment options. You choose how your cash value is allocated and can manage your investments over time.

Variable life policies may expire if the market performs poorly or if you withdraw funds, take out a loan, or use the cash value to pay the premium.

Variable life policies, unlike other cash-value life insurance policies, are classified as securities and are subject to federal securities laws and state regulations. It is critical to understand that the interest (gain) in a variable life policy is not guaranteed. If your investments perform well, the policy's value may rise. However, if your investment decisions are poor or the market falls, you may lose cash value.

How Does Variable Life Insurance Work?

When considering a variable life policy, consider the following important factors:

Premiums: Variable and other types of cash-value life insurance premiums cover policy fees and expenses as well as an amount that goes toward the cash value. Cash value increases help offset rising insurance costs as the insured ages. A person who buys a variable life policy will pay a higher initial premium than is required to cover policy fees and expenses; this "extra" amount can be invested.
Policy fees and expenses: Policy fees and expenses are regular charges that come out of your premium payments or your policy’s cash value. There are numerous costs associated with variable life insurance policies, including investment management fees, sales fees, withdrawal fees, fees for optional features, and administrative fees.
Surrender fees: Most insurance companies charge a fee if you surrender or reduce the face amount of your variable life policy before the surrender period expires. A policy surrender occurs when you cancel your policy and withdraw the entire amount in a single lump sum payment. Policies may have a surrender period, such as nine years, during which the surrender charge applies.
Death benefit: This is the amount of money paid to your beneficiary upon your death, also known as the face amount. Although not all variable life policies include a death benefit guarantee, you may be able to obtain one by paying an additional premium. A guaranteed death benefit has the advantage of not falling below the minimum guaranteed amount regardless of market performance. When comparing policies, make sure to ask if the death benefit is guaranteed.
Cash value: The cash value of your policy is the savings and investment component that grows as you make premium payments. The value of a variable life insurance policy is determined by the performance of your investment choices. Some companies may also provide add-on options, or riders, for an additional fee to ensure a minimum cash value accumulation.
Investment options: Variable life policies allow you to invest in a variety of accounts. Mutual funds (stocks, bonds, and securities) and fixed accounts are two options.
Loans and withdrawals: The cash value of your life insurance policy allows you to borrow against it or withdraw from it. Cash-value growth is tax-free. When you borrow money from the policy, the funds are generally not considered taxable. Withdrawals, on the other hand, are subject to taxation.
Prospectus: A prospectus is a legal disclosure that includes information about company management and investment options such as fees, risks, investment objectives, and past performance.

Variable life insurance has several key advantages, including flexible premium payment options and the ability to direct where your cash value is invested. However, fees and charges associated with policy maintenance are deducted from your premiums or cash value. If the cash value is insufficient to cover the required policy fees or premiums, the policy will lapse, and the death benefit will be forfeited.

Pros Explained

Potential for Higher Returns

The ability to invest in various mutual funds and control your investments allows you to capitalize on economic upturns, which can yield more robust returns than other cash-value life insurance policies.

Death Benefit

Because variable life policies are permanent life insurance, they provide a death benefit for life. The death benefit may be flexible, fixed, or guaranteed, depending on the type of policy you choose.

Flexible Premium Options

If you select a flexible premium option and accumulate sufficient funds in the policy's cash value, you can use those funds to pay your premiums or adjust how much premium you pay out of pocket vs. from the policy's cash value.

Variable life insurance policies may allow you to pay fixed or variable premiums. Although flexible premiums are an excellent option, it is critical to pay enough premiums to ensure that the policy's cash value is sufficient to cover fees and expenses, or your policy will lapse (be canceled).

Manage Investments Based on Your Risk Tolerance

Variable life policies give you control over where your money is invested and give you control over your assets—you decide how to allocate the policy's cash value among the available investment accounts. Other cash-value policies do not give you the option of managing the investment portion.

Tax-Advantaged Savings and Tax-Free Death Benefit

There are a few tax advantages to purchasing life insurance:

Policy loans may be tax-free if taken out properly.
Any gains (in the cash value) accumulate tax-deferred.
A life insurance policy's death benefit is tax-free.

Cons Explained

Death Benefit and Cash Value Are Affected by Market Volatility

If the market does not perform well, you may lose money on your investments. When your cash value falls, your death benefit may also decrease in some cases.

Surrender Charges Can Be High

Surrender charges on variable universal life policies can be high, especially in the policy's early years. Surrender fees may be owed not only if the policy is surrendered, but also if the face amount is reduced.

Fees and Expenses Can Be Significant

Fees and expenses can add up quickly, causing your policy to lapse or your premiums to rise. Fees can increase each year, and if the cash value of the policy is insufficient to cover these fees, premiums may rise or the policy may lapse. Consumers should keep an eye on these costs over time.

Policy Loans Could Incur Taxes or Cause the Policy to Lapse

If you want to access your cash value, you can borrow money from a variable life insurance policy in the form of a loan.

If you withdraw or borrow from the policy before meeting certain tax conditions, especially during the first seven years, your withdrawal or loan may be taxed as a modified endowment contract (MEC), and you may lose tax benefits.
If you take out a loan on your policy and then lack the funds to keep it active, the policy may lapse.
When a policy with an outstanding loan expires, the loan amount may be considered a withdrawal (and therefore taxed).
When you borrow against your policy, your death benefit may be reduced.

Your Policy Is Only as Secure as the Insurance Company

If the insurance company that issued the policy goes bankrupt or goes out of business, it may be unable to meet its obligations, such as paying the death benefit on your policy. You could lose your investment as well as any guarantees made by the company. This is true of all cash-value life insurance policies.

Do I Need Variable Life Insurance?

When shopping for life insurance, there are numerous options to consider. Discuss your goals with a licensed financial planner who will work with you to review investment options and insurance providers if you are considering a variable life policy.

Variable life insurance policies are ideal for people who want to combine life insurance with a tax-advantaged investment vehicle, have a high risk tolerance, and want to choose from a portfolio of investment options.

Variable life insurance may be a good long-term investment if you are looking for a long-term investment. However, it is not suitable for short-term savings. Due to the investment component, most policies have years-long surrender periods and involve multiple charges and financial risks.

Even if your investments perform well, you may still lose money if those returns, combined with your premiums, are insufficient to cover policy costs. If you are risk-averse, the policy's cost may not be worth it when compared to less risky cash-value policies, such as a whole life policy.

Variable Life Insurance Example

When you buy a variable life insurance policy, you pay an initial premium payment that the insurance company allocates based on your investment choices.

Assume your initial premium is $25,000, and you decide to invest half of it in a fixed account (which pays a fixed rate of interest of 5%) and half in a mutual fund (which has a variable return).

If the mutual fund account earns a 10% return over the course of the year, the cash value of the account would be $26,875 ($13,125 in the fixed account plus $13,750 in the mutual fund), less any underlying fund charges, policy fees, and expenses.