Variable life insurance is one type of permanent life insurance, meaning the policy guarantees a payout as long as premiums are paid. Variable life insurance policies include a cash value component on top of the traditional death benefit portion. This cash value comes from a part of your premiums and is invested into a stock market fund managed by the insurance company or a company hired by them. While variable life insurance may have the potential for significant gains, it can also be one of the riskier types of life insurance. If you are considering variable life insurance, here is what you may want to know before buying a policy.

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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. When you pass away, your beneficiary receives the death benefit, as long as premiums are paid and the terms of the policy are met. Variable life insurance also has an adjustable death benefit and premiums, making it one of the more flexible life insurance policies available.

How does variable life insurance work?

Variable life insurance includes two components: a life insurance death 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.

Death benefit

As a permanent policy, beneficiaries of a variable life insurance policy will receive a payout when the policyholder dies, as long as the terms of the policy have been met and premiums are paid. This payout is known as the death benefit and is the coverage specified within the policy. For instance, if you buy a policy for $1,000,000 in coverage, the death benefit will be up to that amount. Several factors can impact the exact payout, and it may vary somewhat from the initial coverage amount. Insurance agents may be able to help with these numbers if you’re determining how much life insurance coverage you need.

When a life insurance policyholder dies, the policy beneficiaries have a set amount of time (often a few years) to claim the death benefit from the policy. Policyholders specify within their life insurance plan who their beneficiaries are and what portion of the death benefit each gets. The company will eventually transfer the unclaimed benefits to the local state Department of Revenue as unclaimed property if no beneficiary can be found.

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 profit 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.

Pros

Variable life insurance policies may have significant benefits, including:

  • Financial protection for your family. A permanent life insurance policy may 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 increased 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. Plus, the premiums are adjustable if you have sufficient funds in your cash value account.

Cons

As with anything, potential 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.

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, 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

Unlike term life insurance, whole life insurance is designed to last your entire life. The policy comes with a fixed death benefit, level premiums and provides a cash value account that can grow over time, tax-deferred. You have the option to withdraw or borrow the cash value while you are still living and use the money for any purpose. However, although pulling money out of your cash value can lower your death benefit, the cash value does not add to your death benefit.

Universal life insurance

Universal life insurance is also a permanent policy, meaning it covers you for the rest of your life. This policy builds cash value, which grows based on an interest rate that is tied to the stock market. Unlike some other types of life insurance, you can use your cash value to change the frequency and/or amount of your premiums. You can also adjust the death benefit if your family’s financial needs change overtime.

Guaranteed life insurance

Guaranteed 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 life insurance policies usually have higher premiums and the death benefit amounts are typically lower.

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. Final expense insurance is guaranteed, which means you don’t need to take a medical exam to get approved. However, the premiums are generally expensive despite the fact that it offers a small amount of coverage (usually capped at $50,000 or less).

Frequently asked questions

    • 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.

    • Variable universal life insurance policies may have fixed premiums, but the specifics can be complicated. Some variable life policies use a fixed range, and policyholders can pay anything within that range. In these cases, known as flexible premium variable life insurance, paying more than the minimum on premiums may result in higher investment in the cash value portion of the policy.

      Other types of variable life insurance use a fixed rate that incorporates a portion to be invested in the cash value component. Even with fixed-rate variable life insurance, policyholders may be able to overpay their premiums to increase the money invested in the policy’s cash value portion.

    • One of the benefits of a variable life insurance policy is that you can borrow or withdraw the cash value when you are still living. This money is tax-free and can be used for any purpose. However, when you borrow cash value, you’re essentially getting a loan from the insurance company, which means you have to pay the money back with interest. Also, if you withdraw money, it gets subtracted from your death benefit, lowering the amount of money your beneficiaries will receive.
    • 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, you could also risk losing coverage if your cash value is insufficient to cover the minimum amount.