What Is Variable Life Insurance?

Definition & Examples of Variable Life Insurance

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Variable life insurance is a type of permanent life insurance that provides a death benefit throughout your life as well as the ability to build cash value through investment options that you can manage. Although this type of policy is riskier than other cash-value policies, it provides the opportunity for greater returns. 

If you are looking into options for life insurance with investment features, read on to learn about the basics of a variable life policy and how it works.

What Is Variable Life Insurance?

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

Variable life falls into the category of cash-value life insurance, which means that in addition to providing a death benefit, it doubles as a savings or investment vehicle that allows you to get money from the policy as needed (through loans or withdrawals) throughout your life. The main difference between variable life insurance and other types of cash-value life insurance is that you can choose from a portfolio of securities in which to invest your cash value.

Investment options typically include managed mutual funds, stocks, bonds, and fixed accounts. You select how you want your cash value allotted and can manage the investments you make over time.

Variable life policies are at risk of lapsing when market performance is poor, or when you withdraw funds, take a loan, or use the cash value to pay for the premium.

Unlike other cash-value life policies, variable life policies are categorized as securities and are subject to federal securities laws and state regulations. It’s important to note that the interest (gain) in a variable life policy is not guaranteed. If your investments perform well, the policy could increase in value. But if your investment choices are not sound or the market takes a downturn, you can lose cash value.

How Does Variable Life Insurance Work?

These are fundamental factors to look at when considering a variable life policy:

  • Premiums: Premiums for variable and other types of cash-value life insurance pay for policy fees and expenses, plus incorporate an amount that goes toward the cash value. Increases in the cash value help offset increased insurance costs as the insured ages. Someone who purchases a variable life policy will pay an initial premium larger than what is required to cover policy fees and expenses—it's this "extra" amount that can be invested.

Depending on the type of variable policy you purchase, you may have specified premium payments or flexible ones after the initial upfront premium.

  • Policy fees and expenses: Policy fees and expenses are regular charges that come out of your premium payments or your policy’s cash value. Variable life policies have many different types of costs, such as investment management fees, sales fees, withdrawal fees, fees for optional features, and administrative fees.
  • Surrender charges: Most insurance companies charge a fee if you surrender your variable life policy or decrease the face amount before the surrender period expires. A policy surrender is when you cancel your policy and withdraw all the money in one lump sum payment. Policies may have a surrender period of a certain number of years, such as nine, during which the surrender charge applies.
  • Death benefit: Also known as the face amount, this is the amount of money paid to your beneficiary upon your death. Not all variable life policies have a death benefit guarantee, but you may be able to pay an additional premium to obtain one. A guaranteed death benefit is an advantage because the death benefit will not fall below the minimum guaranteed amount, regardless of market performance. Be sure to ask if the death benefit is guaranteed when comparing policies.

If the variable life policy does not have a guaranteed death benefit, then your death benefit could be reduced to zero by poor market performance.

  • Cash value: The cash value is the savings and investment part of your policy that builds as you make premium payments. The value in a variable life policy depends on the performance of your investment choices. Some companies may also offer add-on options, or riders, for an additional cost to guarantee a minimum accumulation in the cash value.
  • Investment options: Variable life policies allow you to choose where to invest using different accounts. Choices include mutual funds (stocks, bonds, and securities) or fixed accounts.
  • Loans and withdrawals: The cash value allows you to take loans from your life insurance policy or make withdrawals. Cash value growth is tax-advantaged. When you take money from the policy in the form of loans, the funds are generally not considered taxable. Withdrawals, on the other hand, are. 
  • Prospectus: The prospectus is a legal disclosure that outlines information about company management and includes details about investment options, such as fees, risks, investment objectives, and past performance.

When shopping for a variable life insurance policy, obtain information about fees and the performance of investment options by asking for a prospectus.

Variable life insurance has a couple of key benefits, such as flexible premium payment options and the ability to control where you want your cash value invested. However, fees and charges associated with maintaining the policy come out of your premiums or cash value. If the cash value is not sufficient to pay the required policy fees or premiums, the policy can lapse—and you would lose the death benefit.

Pros
  • Potential for higher returns

  • Death benefit

  • Flexible premium options

  • Manage investments based on your risk tolerance

  • Tax-advantaged savings and tax-free death benefit

Cons
  • Death benefit and cash value are impacted by market volatility

  • Surrender charges can be high

  • Fees and expenses can be significant

  • Policy loans could incur taxes or cause the policy to lapse

  • Your policy is only as secure as the Insurance company

Pros Explained

Potential for Higher Returns

Being able to invest in various mutual funds and control your investments allows you the opportunity to take advantage of economic upturns, which can yield more robust returns relative to other cash-value life insurance policies.

Death Benefit

Since variable life policies are permanent life insurance, one advantage is that they offer a death benefit for life. Depending on the type of policy you choose, the death benefit may be flexible, fixed, or guaranteed.

Flexible Premium Options

If you choose a flexible premium option, and build enough funds in the cash value of the policy, you can use those funds to pay your premiums or adjust how much premium you pay out of pocket vs. from your cash value.

Variable life policies may provide the option to pay specified or variable premiums. Although flexible premiums are an excellent option to have, it’s important to pay sufficient premiums to make sure the policy’s cash value is enough to cover fees and expenses, or your policy will lapse (be canceled).

Manage Investments Based on Your Risk Tolerance

Variable life policies allow you to manage where you invest your money and to have control of your assets—you’re responsible for choosing how to allocate the policy’s cash value between the available investment accounts. Other cash-value policies do not allow you to manage the investment portion.

Tax-Advantaged Savings and Tax-Free Death Benefit

Life insurance has a few tax advantages:

  • When you take out policy loans, they may be tax-free 
  • Any gains (in the cash value) accumulate on a tax-deferred basis
  • The death benefit of a life insurance policy is tax-free

Cons Explained

Death Benefit and Cash Value Are Impacted by Market Volatility

If the market does not perform well, you are at risk of losing value in your investments. In some cases, the death benefit may also decrease when your cash value drops.

Surrender Charges Can Be High

Variable universal life policies may have high surrender charges, especially in the policy’s early years. Surrender charges may be owed not only if you surrender the policy, but also if you decrease the face amount.

Fees and Expenses Can Be Significant

Fees and expenses can be significant and cause your policy to lapse or premiums to increase. Fees can increase every year, and if the policy’s cash value is not sufficient to cover these fees, the premiums may go up, or the policy may lapse. Consumers should be vigilant about these costs over time. 

Policy Loans Could Incur Taxes or Cause the Policy to Lapse

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

  • If you take a loan from the policy before meeting certain tax conditions, in particular in the first seven years, your withdrawal or loan could be taxed as a modified endowment contract (MEC), and you could lose tax benefits.
  • If you take out a loan on your policy and then do not have the funds to maintain the policy in force, the policy may lapse.
  • When a policy lapses with an outstanding loan, the loan amount may be treated as a withdrawal (and therefore taxed).
  • Your death benefit can be reduced when you take a loan from the policy.

Your Policy Is Only as Secure as the Insurance Company

If the insurance company that issues the policy is in financial distress (or fails), it may not be able to meet its obligations (such as paying the death benefit on your policy). You could lose your investment or any guarantees that the company has made. This is the case with any cash-value life insurance policy. 

Do I Need Variable Life Insurance?

There are many types of life insurance to consider when you are looking for life insurance. If you are considering a variable life policy, discuss your goals with a licensed financial planner who will work with you to review investment options and insurance providers.

Variable life insurance policies are best suited for those who want to combine life insurance with a tax-advantaged investment vehicle, have a tolerance for risk, and want to choose between a portfolio of investment options.

If you are looking for a long-term investment, then variable life insurance may be a good option. But it is not suited for short-term savings. Most policies have years-long surrender periods and involve multiple charges and financial risks due to the investment portion.

Even if your investments experience gains, you could still lose money if those gains plus your premiums aren’t enough to offset policy costs. If you are risk-averse, the cost of the policy may not be worth it compared to other types of less-risky cash-value policies, such as a whole life policy.

Variable Life Insurance Example

When you purchase a variable life policy, you start with an initial premium payment, which the insurance company allocates per your investment choices.

Let’s say your initial premium is $25,000, and you decide to allocate 50% to a fixed account (which pays a 5% fixed rate of interest) and 50% to a mutual fund (which has a variable return).

If over the year the mutual fund account has a 10% return, 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.

Key Takeaways

  • Variable life insurance can provide lifelong coverage and is suited for people who are comfortable taking investment risks with their life insurance policy’s cash value.
  • Variable life insurance can be more expensive than term or other permanent life insurance due to the fees and policy charges associated with policy management and investment options. 
  • You can make money if your investments do well, but you can also lose money if your investments perform poorly.
  • A variable life insurance policy may lapse if you do not pay the premiums or do not have sufficient cash value to cover the policy’s fees and expenses.
  • Consult the prospectus and review your options with a financial planner or licensed advisor before making any decisions about purchasing a variable life insurance policy.
  • If the insurance company that provides your variable life policy is not financially stable, it may not be able to honor the contract, and you could lose your investment.