There are several types of permanent life insurance, one of which is variable life insurance, which provides lifetime coverage and generates a cash value that gets invested directly in the stock market and grows based on the fund’s performance. While variable life insurance has the potential for big gains, it’s also one of the riskier types of life insurance. If you are considering variable life insurance, here is what you should 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. 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.

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 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

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. Plus, the premiums are adjustable if you have sufficient funds in your cash value account.

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.

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 can 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 can be a good option. However, keep in mind that guaranteed life insurance policies 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 can 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.
    • 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.
    • The amount of life insurance you’ll need depends on your family’s financial needs. If you only need coverage 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 money to heirs. To determine how much coverage you need, you can use a life insurance calculator and then discuss the results with a licensed agent.