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Variable life insurance is a type of coverage that provides more flexibility than other types of life insurance and gives policyholders more say in their life insurance investments.
Variable life insurance might be a good fit for your long-term insurance, investment and tax-planning needs, but you need to take an active role in deciding investment options—unlike other policies like whole life insurance.
How Does Variable Life Insurance Work?
Similar to other types of life insurance, a variable life insurance policy pays a certain amount to your beneficiaries, such as your family, after you die. Typically, the death benefit for a variable life insurance policy exceeds the amount of premiums paid.
Variable life insurance includes a cash value component whose value changes based on:
- Amount of premiums paid
- Fees and expenses charged by the insurance company
- Performance of the investments (often similar to mutual funds) tied to the policy
- Loans or withdrawals taken from cash value by the policyholder
One difference with other types of policies is that variable life insurance gives a policyholder freedom to decide how to invest the money.
Life insurance and wealth consultant Guy Baker, founder and managing director of the Wealth Teams Alliance wealth advisory firm, notes that variable life insurance policyholders often use the policies to provide extra retirement income through loans taken out based on the policy’s cash value. A policyholder isn’t required to pay federal taxes on the money that’s borrowed (unless it’s never paid back).
A variable life insurance’s cash value investment account can contain dozens of sub-accounts. Part of the premiums also can be put into a non-investment account, or fixed account, that pays interest on the money deposited in it.
To cover the fees and expenses charged under the policy, you must pay a certain amount of premiums or maintain a sufficient cash value.
Variable Life Insurance vs. Variable Universal Life Insurance
Both variable life insurance and variable universal life insurance are types of permanent life insurance, which offers lifetime coverage. They both offer investment options, such as stocks, bonds and mutual funds. And they’re both “variable” because their cash value can vary based on market performance. But they’re not the same kind of coverage.
The big difference between variable life insurance and variable universal life insurance is the flexibility of the premiums:
- Variable universal life insurance: You can increase or decrease premium amounts within a set range.
- Variable life insurance: Does not allow you to raise or lower premium amounts.
Furthermore, there’s a difference with the death benefit:
- Variable life insurance: Guarantees the death benefit won’t fall below a specific dollar amount, regardless of investment performance.
- Variable universal life: Allows a policyholder to increase or decrease the death benefit, no matter how the cash value investment account is performing. But that’s possible only if the policyholder agrees to adjust the premiums they’re paying.
Pros and Cons of Variable Life and Variable Universal Life Insurance
Who Is Best for Variable Life and Variable Universal Life?
Variable life and variable universal life policies are best for people who can afford to absorb losses if the underlying investments don’t perform as well as projected, such as those with considerable wealth, says Baker.
And the SEC advises: “Consider whether you can afford the policy. The fees and expenses associated with the insurance policy may be significant,”
If you do purchase this sort of coverage, keep in mind that you might lose money, including your initial investment.
Tips for Buying Variable Life and Variable Universal Life
Never pick one of these life insurance policies based on quoted premiums or projected asset growth, suggests Barry Flagg, president and founder of life insurance data and research provider Veralytic.
“Regulations in most states for most product types permit agents, brokers or insurers to quote low premiums and/or project high account growth while charging high costs but without disclosing the higher risk of a ‘premium call,’ under performance or even policy lapse,” Flagg says.
A premium call requires a policyholder to put more money into their account.
Rather than relying on quoted premiums or projected asset growth, Flagg recommends choosing coverage based on internal policy costs and the historical performance of the investment funds underlying the policy. High internal costs can lead to higher premiums and lower cash value.
Other tips for buying variable life or variable universal life insurance include:
- Obtain quotes from several insurance companies. Rates will vary by company based on factors like age, gender, health history, smoking status and coverage amount.
- Check an insurer’s financial strength. Since you’re buying a long-term contract, you want to select a company that’s going to be around for the long haul, offering better odds that a future claim will be paid.
- Look for insurers that charge low fees for investment options.
- Seek policies that are poised to generate solid returns while also easing your tax burden.
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