Variable life insurance is a permanent life insurance policy that also where the cash value growth is partially dependent on investment performance.  To tie the cash value to investments, the policy has a cash value account that is invested in a number of sub-accounts available within the policy. A sub-account is essentially a mutual fund, but the exact fund is only available within the policy and not available to the general investing public.  Usually, the fund mimics a widely available fund, but with a different fee structure.   With variable life insurance, there will be several sub-accounts to choose from, with a variety of them offering between 30 and 50 different options.

The cash value within a variable life insurance policy has the potential to grow over time if the accounts where the money invested perform well.  It will grow if the underlying investments in the policy’s sub-accounts also grow.  For reference, a mutual fund is an investment vehicle that invests in stocks and bonds and other investible assets such as commodities.  As these investments drop or rise – the cash value will as well.

The appeal behind investing the cash value of a life insurance policy into variable funds is that the cash value can grow more quickly, but the policy still receives favorable tax treatment of life insurance.  When the cash value of a life insurance policy grows, the gains are not taxed as income.  Additionally, unless the policy is a modified endowment contract, the gains come out last (FIFO taxation).  Loans are also taken tax-free.

Downside of Utilizing Variable Life Insurance

The biggest downside of variable life insurance is the risk.  If the sub-accounts that the cash is invested in perform poorly, the cash value can fall or rise more slowly than a traditional whole life policy.  Another of the biggest downsides to utilizing variable life insurance are the fees associated with it. While every permanent life insurance policy comes with fees, variable life insurance tends to have the highest because the commissions are high and the investment management fees are high. Variable life insurance policies will usually have the following costs:

  • Sales and Administrative Fees– This is essentially the commission fees paid to the agent.  These can be higher in variable policies.
  • Mortality and Expense Risk – This is typical of any life insurance policy, and is not generally higher just because it is a variable policy.
  • Investment Management Fees– These can really add up.  Each sub-account has a unique fee structure which takes a percentage of the cash invested into the account each year.  This is unique to variable life insurance
  • Policy Loan Interest- If applicable.  The life insurance company charges interest on loans taken from a life insurance policy at a specified rate.  These are typically the same across all permanent forms of life insurance for a given company.
  • Surrender Charges- Variable life insurance can have high surrender charges.  This is the cost to surrender the policy and take out your cash value.  It is a percentage of the total cash, and it diminishes to 0% over time.  Surrender charges can apply for up to 12 years in some cases and much fewer years in other cases.

Because the fees can be substantial with variable life insurance, it is especially important to compare life insurance quotes from multiple companies.  Each company can have a very different cost and fee structure, especially when it comes to surrender charges.

The administrative fees for a variable life insurance policy will be higher because these policies are SEC-regulated investments. As the insurer passes additional charges on to you, it should be considered when you determine how to invest the policy’s cash value.

If you decide to choose conservative instruments, you are likely to have gains that correlate with a whole life insurance policy’s cash value – but a whole life insurance policy will have lower fees. Therefore, with the same cash value rate of return, you will actually perform worse with a variable life insurance policy.

Variable Life Insurance Death Benefit

variable life performance
The stock market can be volatile. Variable life has risk.

With a variable life insurance death benefit, the death benefit of a policy is structured in one of the following ways:

  1. Level Death Benefit – The death benefit is equal to the face value of the policy when you purchased it.  You may still choose a variable policy with a level death benefit because if the cash value grows quickly you could stop paying premiums into the policy early.
  2. Face Amount Plus Cash Value – This form of policy will usually cost more but your beneficiaries will receive your cash value in addition to the policy’s face value.  With a variable policy, this could result in more total benefit to beneficiaries than a traditional whole life policy.
  3. And to be creative, some variable life insurance policies provide other death benefit structures such as totaling the policy’s face value plus all life insurance premiums paid.

No matter how your death benefit is structured, you will always want to check the policy’s actual terms. You need to confirm whether the death benefit is guaranteed and if the value is the same as what is projected by looking at the performance over time compared to the illustration that was proposed to you when you purchased the policy.  The death benefit is a target using an assumption of cash value performance, such as a 4% annual rate of return. The insurer will project that the cash value will equal the policy’s face value when you pass away. However, if your cash value underperforms, it may reduce your death benefit all depending on your policy’s term.  You can actually request an updated illustration at any time, and you should do this regularly such as every year.

How the Stock Market Affects Variable Life Insurance

Now for the most important question, how exactly does the stock market affect variable life insurance? Well, as mentioned previously, the sub-accounts within variable life insurance are invested or can be invested in the stock market. As these accounts are invested into stocks, if the stock market takes a dip – then your earnings and cash value will as well. This is why you need to ensure that you are investing wisely by working closely with a financial advisor.  Ideally, you will have a mix of funds that are somewhat protected from a drop in the stock market.

With variable life, it is generally not a great idea to invest in highly volatile funds.  Life insurance proceeds will build over time naturally and investing in proper stocks will give them the little push that will benefit you down the road. You do not want to take the chance on investing in poor stocks that will tank your cash value. Having said that, variable life insurance is a great way to invest in stocks and build substantial cash value over time that will benefit both you and your family down the road.

It is important to contact a life insurance agent and seek further financial information regarding investing your cash value and the stock market. Life insurance agents will be able to find the most suitable policy for you.  They can also help you choose investments, and maintain the proper mix of investments in the policy.

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