Variable life insurance gives policyholders a unique opportunity to take charge of their policy’s growth potential. Unlike other life insurance policies that accumulate cash value, variable life shifts the investment control to you, allowing you to direct your policy’s cash value into various stock and bond accounts. The upside? Your policy’s cash value can grow significantly when the market performs well. But there’s a catch: there are very few guarantees. Market dips can affect your cash value, meaning you shoulder both the rewards and the risks. For those intrigued by the balance of flexibility and potential in variable life insurance, here’s what to consider before making this policy part of your financial strategy.
What is variable life insurance?
Variable life insurance is a unique kind of permanent life insurance that combines lifelong insurance coverage with an investment element. This policy is designed to provide a guaranteed minimum death benefit for your beneficiaries, but it also lets you grow its cash value by investing part of your premium in various funds, such as stock or bond portfolios. When these investments perform well, the cash value and possibly the death benefit can grow. But if the market takes a downturn, the cash value and added benefits may decrease, making this policy’s value subject to frequent changes.
Because of this investment component, policyholders should be comfortable with risk, as the cash value in a variable life policy can fluctuate daily. It’s a long-term commitment and isn’t suitable for everyone, especially those who prefer more stability. Agents selling variable life insurance must hold a securities license from the SEC, and policies are issued with a prospectus — a document outlining the details, fees, taxes, commissions and potential outcomes of the investment choices. This ensures policyholders understand the risks and rewards of investing within an insurance policy.
How does variable life insurance work?
Variable life insurance combines the long-term protection of a permanent life insurance policy with an investment component, allowing policyholders to potentially grow their cash value based on market performance. Here’s how it works: each premium payment is divided into two parts. The first portion goes toward the cost of insurance and administrative fees, while the remainder is invested in separate sub-accounts, which could include stock, bond, treasury or money market funds. While you choose the funds, the insurer decides on the specific assets bought and sold within each, which means you have input on the investment strategy but not full control.
Unlike other policies with guaranteed growth, variable life insurance cash value can fluctuate with market performance. This means you could see substantial gains or losses based on how well the investments perform. Because of this risk, regular monitoring is critical, as a downturn in cash value can lead to higher costs or even policy termination if the balance drops too low to cover fees.
Here are a few key aspects to remember:
- Investment flexibility: You decide where to allocate funds, which gives you the potential for growth but requires comfort with market risks.
- Accessing funds: You can take loans against your cash value, just like with whole life insurance. These loans accrue compounding interest, so it’s important to plan repayments to prevent long-term costs.
- Cash value sensitivity: Given the potential for daily fluctuations in value, you’ll need to stay actively involved to ensure the policy doesn’t lapse or lose significant value.
- Death benefit: The death benefit in a variable life policy can increase if investments perform well. However, it’s not guaranteed to grow, and poor market performance could reduce additional benefits, though the minimum death benefit remains protected.
- Surrender cash value: Like whole life policies, if you decide to surrender your variable life insurance policy, you’ll receive the accumulated cash value minus any fees or penalties. Keep in mind that surrender charges can apply, especially in the early years of the policy, and any outstanding loans or interest will reduce the amount you receive.
Pros and cons of variable life insurance
Considering variable life insurance? Here are some benefits and drawbacks to weigh:
Pros
- Financial protection: Variable life insurance provides a guaranteed death benefit that could help cover end-of-life expenses and offer financial security for your loved ones.
- Potential for increased death benefit: If your policy’s investments perform well, those gains may be used to increase the death benefit. However, this increase fluctuates and isn’t guaranteed.
- Investment flexibility: Policyowners have a range of investment options, such as stock, bond and money market funds, which allow for customization based on individual financial goals and risk tolerance.
Cons
- Fixed premiums: Traditional variable life insurance policies have set premium amounts that cannot be adjusted unless you have a specific variable adjustable policy.
- Reduced investment returns: Unlike standalone investment accounts, returns in a variable life policy are lowered by sales loads, mortality charges and surrender fees — especially in the early years.
- Market risk: Investment values within variable life insurance are subject to market fluctuations. Poor performance can reduce your cash value, and insufficient funds could lead to policy termination without careful monitoring.
- Limited investment selection: While variable life policies offer several investment options, they’re typically limited to specific funds managed by the insurer, which may not align fully with broader financial goals.
Alternatives to variable life insurance
Variable life insurance is not the only life insurance option available. Below, we discuss popular life insurance policy types that may be a good alternative if variable life isn’t the right choice for you.
Term life insurance
Term life insurance offers coverage over a set period of time — usually 10, 15, 20, 25 or 30 years. If you pass away during the term, your beneficiary receives the death benefit. If you outlive the term, your coverage ends. Term life insurance may be beneficial if you need coverage for a certain period of time or if you want a cheaper premium. Unlike a permanent life insurance policy, term life insurance does not generate cash value.
Whole life insurance
Whole life insurance is a permanent policy that lasts your entire life, typically up to a coverage age range of 95 to 121. It offers level premiums, a fixed death benefit and a cash value that grows over time. Although you can take policy loans against the cash value, withdrawals aren’t permitted, and the cash value itself doesn’t increase the death benefit. Whole life can be appealing for those seeking lifetime coverage with steady growth.
Universal life insurance
Universal life insurance is a permanent policy that offers flexibility in premium payments and death benefits. The cash value in UL policies grows based on an interest rate set by the insurer, offering more stability than variable life. Policyholders can adjust premiums (if there’s sufficient cash value) and modify death benefits over time. Universal life may suit those looking for a blend of permanent coverage and some customization.
Indexed universal life insurance
Indexed universal life insurance is a type of universal life policy where cash value growth is linked to a specific market index, like the S&P 500, allowing for higher potential returns compared to standard UL policies, though the maximum return is capped. The principal amount is protected from market loss, making IUL a potentially good choice for those seeking market-related growth with some downside protection.
Guaranteed issue life insurance
Guaranteed issue life insurance is a type of whole life insurance that allows policyholders to get coverage without taking a health exam. If someone with significant health concerns isn’t accepted by other insurance policies, guaranteed life insurance may be a good option. However, keep in mind that guaranteed issue life insurance policies usually have higher premiums and the death benefit amounts are typically lower. There is also a waiting period for the full death benefit. Typically, if you die within the first two years your beneficiaries only receive a refund of paid premiums — unless the death is accidental.
Final expense insurance
Final expense insurance is meant to finance funeral costs and other end-of-life expenses. When you pass away, final expense insurance may protect your loved ones from having to worry about paying for your funeral costs while grieving. Most final expense policies offer guaranteed approval, which means you don’t need to go through any medical underwriting. These policies typically offer a small amount of coverage (usually capped at $25,000 or less) for relatively high premiums. Some final expense policies offer higher amounts of coverage (generally up to $50,000 to $75,000) but may also require a health questionnaire for approval.
Frequently asked questions
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The best life insurance company will vary for every policyholder, based on the type of policy you are looking for, as well as any riders or company features — like a mobile app — you might want. To make your choice, you may want to talk with a licensed insurance agent to help you determine your needs.
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Yes, variable life insurance typically has fixed premiums if it’s a traditional fixed-rate variable life policy. With this type, the premium remains consistent over time, with a portion allocated towards the policy’s cash value component. However, there is also a type called variable adjustable life insurance, where the policyholder has some flexibility to adjust premiums within certain limits. Paying above the minimum on these policies may help build cash value more quickly.
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With a variable life insurance policy, you can take out a loan against your cash value, which grows based on your investment choices. When you borrow from your policy’s cash value, it’s treated as a loan from the insurer. This means you’ll pay interest on the borrowed amount, but it typically won’t be taxed, as long as the policy remains active. However, any outstanding loan balance, including interest, will reduce your death benefit if not repaid, which could lower the financial support your beneficiaries receive.
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The greatest risk in a variable life insurance policy is the risk of the investments. The insurance company doesn’t guarantee any rate of return (in most cases) and doesn’t offer protection for investment losses. Like any investment, the cash value component of a variable life insurance policy comes with risk. If you use your cash value to pay your premium or take out policy loans, you could also risk losing coverage if your cash value is insufficient to cover the minimum amount required to keep the policy in force (active).
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Variable universal life insurance combines the flexible premium and death benefit options of universal life with the investment flexibility of variable life. With a VUL policy, you can choose between a level or increasing death benefit, allowing for more tailored financial planning. Premiums are flexible, so you can adjust your payments within certain limits depending on your needs and policy performance. Additionally, VUL policies offer both policy loans and withdrawals, giving policyowners more ways to access their cash value, although these actions can impact the policy’s value and benefits over time.
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