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The Benefits of Variable Life Insurance
When you buy life insurance, you’re investing in the future. You buy your policy to make sure your loved ones have what they need after you’re gone. But not all life insurance is created equal.
Have you ever wondered, “Is life insurance worth it?” If you’re interested in buying a policy that can offer benefits for both you and your loved ones, you’ve got options. Some policies can offer cash value to you while you’re living, and variable life insurance falls in that category.
What is variable life insurance?
Variable life insurance, also called variable universal life insurance, is a type of permanent life insurance. Variable life policies resemble their more conventional cousin, the universal life policy, in that they are composed of two parts — the life insurance and the investment fund.
- The life insurance: This portion of your policy acts just like any life insurance policy. By paying your premiums, you guarantee that a death benefit (a lump sum amount you choose) will be paid out to your beneficiaries (the people you name in your policy) at the time of your death.
- The investment fund (cash value): When you pay your premiums on a variable universal life insurance policy, a portion of those premiums goes into an investment fund that you can allocate however you’d like. The value of this portion of your policy depends on how well your investments perform and whether or not you withdraw cash value from your policy (more on that later).
Unlike a universal life policy, you as the policyholder have a great deal of latitude in choosing where your premiums are invested. Typically, the choices range from stocks and bonds to mutual funds. Because these are securities-based investments, regulations require that you receive a prospectus before investing. The reason is that, like all securities investments, there is the possibility of total loss.
Variable life is different from other types of insurance, which are exclusively regulated at the state level. Thanks to the very robust investment portion of this product, it is subject to federal investment regulations.
That means insurance agents who want to sell this product must not only be licensed by their home state, they must also become federally registered brokers. Registered securities brokers must pass a rigorous exam administered by the National Association of Securities Dealers.
Since this is a hybrid insurance-and-investment product rather than a fixed premium, there is a pre-established range of premium payments. You can choose the payments so long as they fall between the minimum and maximum allowable amounts. The minimum premiums are intended to cover most or all of the insurance costs.
The flexible premiums allow you to grow your cash value at your own pace, so the more you pump in, the faster it grows. That is, unless your investments are performing poorly –in which case your cash value will decrease. When your investments are performing well, you also have the option to use the interest and dividends to pay a portion or all of your insurance premium.
Cash value in variable life insurance
The cash value portion of your variable life policy is the investment fund. You can leave this in place to let your investment grow, borrow against it (for example, use it as collateral for a loan) or withdraw it. If you leave your cash value in place, you get to allocate how it gets invested, whether that’s in bonds, a money market fund, an index like the S&P 500 or elsewhere. Your policy usually offers at least a couple dozen different investment options.
But designating that money to specific investments doesn’t happen for free. Your variable life policy comes with basis points for each investment option it offers. That basis point equals a percentage (usually 0.1%) that your life insurance company will claim on any returns you see. Evaluate the basis points associated with each investment option as you’re deciding where to invest your money. If two options have a similar historic rate of return but one comes with more basis points, it’s probably wiser to choose the option with fewer associated basis points.
Your cash value accumulates on a tax-deferred basis, which includes dividends and interest, until it’s withdrawn from the policy, with the exception of loans.
Variable life policyholders, like whole life policyholders, can borrow against the cash value without having to pay taxes on the gains.
That means, unlike traditional investments, you could borrow indefinitely without having to pay capital-gains taxes. The very serious downside to this strategy is that if the loan ever equals the policy’s cash value, the policy will lapse and the taxes on the income will come due all at once. This can happen if the value of investments in the policy suddenly decreases due to poor market conditions.
Death benefit and variable life insurance
Now that we’ve explored the second component of variable life insurance, let’s look more closely at the standard life insurance portion of it. You’re probably wondering what happens to the cash value you’ve accrued at the time of your death. And you have a choice to make here.
When you buy variable life insurance, you can choose between:
- A level death benefit: If you choose this policy type, your policy pays out the flat lump-sum death benefit you agree upon with your insurer to your beneficiaries. The insurance provider then gets your cash value. These policies are generally cheaper because your insurer can apply the accrued cash value toward the death benefit, lessening the financial burden on them at the time of your death.
- An endorsement to pay out your death benefit plus cash value: When you buy your policy, you can purchase an endorsement that dictates that the cash value of your policy goes to your beneficiaries. Choosing this option will increase the premiums associated with your variable universal life insurance policy.
Your responsibilities as a variable policyholder
As the policyholder, you have the ability to change your investment mix at any time. For example, you can move from a stock-heavy portfolio to a bond-heavy portfolio at will. Like any other investment account, the risks and rewards of those choices are yours alone.
There are usually fees and expenses associated with these transactions, and their amounts can vary from one insurer to another, so it is important to understand how much they are and how they will affect your cash value.
These policies do not come with investment advice or advisors and there are few, if any, protections against losses. You are personally responsible for understanding what you’re investing in and what the potential risks are.
It is important to remember that variable life insurance policies are more than just investments; they are life insurance policies, and if they are your primary source of life insurance you must weigh the risks of losing coverage against the gains from investments. Many insurance professionals, including me, do not recommend variable life insurance policies as a primary source of life insurance coverage due to their volatile nature.