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Variable life insurance

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Variable life insurance is a type of life insurance with a cash-value component that is invested, typically in mutual funds. The cash value accrual depends on the performance of these funds; you could earn or lose cash value depending on how the funds perform. While variable life insurance isn’t likely to be a good fit for average consumers, it may be a good choice for those looking for coverage with an investment option.

If you’re curious to find out if variable life insurance is the right policy type for you, Bankrate outlines what it is, how it works and who it may be right for.

What is variable life insurance?

Variable life insurance is a type of permanent life insurance. Unlike term life insurance, permanent policies are designed to last for the entirety of your life. Variable life includes a death benefit for your beneficiaries and cash value that has various investment options. The cash value is most commonly invested in mutual funds.

How does variable life insurance work?

Variable life insurance includes two components: a life insurance benefit and a cash value account that is invested in various funds, usually mutual funds. The money from your insurance premium is used in a few ways.

First, the insurance company keeps a portion of the money for account maintenance and fees and puts some money toward the death benefit. The rest of the money goes toward your policy’s cash value, which, in a variable life policy, is essentially an investment account. As the policyholder, you can choose how that money is invested.

Cash value component

When you purchase a variable life policy, you’ll receive a prospectus with all of your investing options. The cash value can be invested in numerous ways, but the most common way is to invest in mutual funds. You may also be able to invest in index funds, equities, bonds or money market funds. Most insurance companies also offer a fixed interest investment option.

If your cash value investment does well, you have several options. You can use the money to increase the death benefit, withdraw the money as cash or use the funds as collateral for a loan. However, most insurance companies put a cap on the maximum rate of return, so your earning potential isn’t endless. You’ll also have to pay management fees based on how your cash value is invested.

Here’s a real-world example. Say your variable life insurance premium is $300, and $200 of it goes into your cash value account. Based on the market’s performance, you can choose which fund you want to invest that $200 into. Over 10 years, your $200 grows to become $2,000. At that time, you can either pull out the $2,000 and use it as cash, add it to your death benefit, or use it as loan collateral. Keep in mind a small percentage would be allocated toward fees.

As with any investment, your cash value is influenced by the performance of the stock market. The market rises and falls, which means you could either earn money or lose money. That’s both a pro and a con to variable life insurance. You have full control over where you invest the money but there’s no guaranteed rate of return. Your cash value could appreciate or depreciate, depending on what the market does.

Pros and cons of variable life insurance

Is variable life insurance right for you? That likely depends on your preferences and financial situation. Below, we outline the pros and cons.

Pros

Variable life insurance policies have significant benefits, including:

  • Financial protection for your family. Any life insurance policy can be beneficial to help cover end-of-life expenses and provide a financial cushion for your family should you pass away. Despite the added risk, variable life insurance accounts still offer a death benefit.
  • A potentially increasing death benefit. While you are still living, you may have the option to convert your cash value into a higher death benefit amount. That way, when you pass away, your beneficiaries will receive a larger payout from the policy.
  • Flexibility and choice. Policyholders get to choose from several funds when deciding where to invest their money.

Cons

As with anything, downsides to variable life insurance do exist. These cons may include:

  • High premiums. The premiums for variable life are generally pricier than other types of life insurance and you may also have to pay management fees for your investments. Because the market is volatile, you could end up losing your cash value if the market has a bad year.
  • Capped returns. Unlike some investments outside of life insurance, the amount of money you can make on your cash value in a variable life policy is limited.
  • Limited investment options. You will likely choose from a set number of funds that operate like mutual funds. If the available funds don’t meet your needs, you may be better off investing outside of a variable life insurance policy.
Pros Cons
Protect your family financially Generally expensive
Death benefit could increase Returns are capped
More flexibility than other life insurance policy types Investment options are limited

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 your lifestyle.

Term life insurance

Term life insurance offers coverage over a set period of time — usually 10, 20 or 30 years. After this period the policy expires, the policyholder no longer pays their premium and their beneficiaries no longer receive a death benefit if the policyholder dies. While term life insurance is beneficial if you need coverage for a certain period of time or if you want lower average premiums, it may not be the best choice for everyone. If you live longer than your chosen policy term, your beneficiaries will be left without a payout.

Whole life insurance

Unlike term life insurance, whole life insurance is designed to last your entire life. The policy comes with a set death benefit and provides a cash value account that can grow over time, tax-deferred.

Universal life insurance

Universal life insurance is also a permanent policy, meaning it covers you for the rest of your life. Your beneficiaries will receive a death benefit when you pass away. Universal life policies also have cash value accounts that build interest.

Guaranteed life insurance

Guaranteed life insurance is a type of whole life insurance that allows policyholders to get coverage without getting a health exam. If someone with significant health concerns isn’t accepted by other insurance policies, guaranteed life insurance can be a good option However, keep in mind that since guaranteed life insurance policies are risky for providers, premiums are often high and the death benefit amounts are typically low.

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 can protect your loved ones from having to worry about finances while grieving. Death benefit levels for final expense insurance are typically relatively low.

Frequently asked questions

What is the best life insurance company?

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.

Is variable life insurance expensive?

Generally yes, variable life insurance is more expensive than many other types of life insurance policies. When your money is invested, you will likely pay management fees to keep your money in the market. This is on top of the premium you pay to keep the policy active.

What is the greatest risk in a variable life insurance policy?

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 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, you could also risk losing coverage if your cash value is insufficient to handle the cost of the policy.

How do I decide how much life insurance I need?

The amount of life insurance you’ll need depends on your finances and what you want the death benefit to cover. If you are only wanting to provide for end-of-life expenses, you’ll likely need a lower death benefit than someone looking to provide income for their family members or leave a financial gift. To determine how much coverage you need, you can use a life insurance calculator and then discuss the results with a licensed agent.

Written by
Lizzie Nealon
Insurance Writer
Lizzie Nealon is a former insurance writer for Bankrate. Her favorite part of the job is making home, auto and life insurance digestible for readers so they can prepare for the future.
Edited by
Insurance Writer & Editor