Variable Life Insurance

If your income from work pays your family’s bills, you probably need life insurance. For many millennials, a simple term life insurance policy will work.

But life insurance can get complicated. A variable life insurance policy, for example, has an investment component whose value could grow over time.

Do you need a complex life insurance policy such as variable life? Let’s take a closer look to find out.variable life insurance

What Is Variable Life Insurance?

Variable life insurance is a specific type of whole life insurance. On the surface, variable policies work a lot like regular whole life insurance: Your premiums fund a cash account as well as reserving your death benefit.

With variable life insurance, your cash value isn’t just money in a savings account. Instead, you can invest the money, potentially earning a higher return compared to regular whole life.

As a variable life policyholder, you would not have complete control over how your cash value is invested. Your insurance company would provide and manage some sub-accounts typically comprised of mutual funds that track the broader markets.

How Can Variable Life Insurance Policy Work For Me?

Because it is invested in the market, a variable life insurance policy’s cash value can grow faster than a standard whole life policy whose growth resembles a standard savings account.

Your policy’s cash value can also decline if the markets tank as they did in late 2008.

So why would you want investments tied up in an insurance policy? Couldn’t you invest your money in mutual funds or ETFs without involving life insurance?

Of course, you can! And in most cases, you probably should.

Which begs the question:

What Are the Advantages of Having a Variable Life Insurance Policy?

Since you can accomplish the same or better results by investing your money separately from your insurance policy, a variable life insurance policy must have some other advantages.

Elements of the Policy Interact

With permanent life insurance of any type, your cash value, death benefit, and premiums interact, which can work to your advantage.

Let’s say you bought a $250,000 permanent life insurance policy. If you died in the earliest years of your policy, your $250,000 death benefit would be funded by the insurance company just like it would with a term life policy.

But as time passes and your cash value grows, your cash begins to subsidize this $250,000 death benefit.

Potential for Faster Cash Value Growth

The faster growth potential of a variable life policy means you could gain more cash value sooner.

In Year 10 of the policy, for example, you may have accrued $12,000 in cash value, which means the insurance company provides the other $238,000 of your death benefit, reserved by your ongoing premiums.

By Year 40 of your policy, your cash value may be funding $150,000 of your death benefit, leaving only $100,000 to be funded by your insurance company.

The more of your policy your cash funds, the more control you have over the policy. For example, you could lower your premiums and keep the same coverage in place.

Tax Advantages

The growth potential in your variable life policy happens without the IRS interfering in most cases.

By paying regular premiums on the $250,000 policy from our example above, you could be effectively saving for retirement as your policy’s death benefit transitions from being funded by the insurance company to being funded by your policy’s accrued cash value.

This performance resembles an IRA — that is, the cash value in your policy grows with a tax-deferred status.

But unlike an IRA, you wouldn’t be restricted by maximum annual contributions, and you wouldn’t have to stop contributing when you reach a specific age. You also would not be required to make mandatory IRA withdrawals.

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Disadvantages of Variable Life Insurance

Does variable life insurance have some drawbacks? It most definitely does, and they include:

More Expensive

Whole life insurance costs significantly more than term life. Variable life is among the more expensive kinds of whole life insurance.

If you simply need coverage in place to protect your family in case you die unexpectedly, you’ll get a much better deal with term life insurance.

Lower Coverage Amounts

You can get millions of dollars in term life coverage, which you may need if you earn more than $100,000 a year and want to provide for your family even after your death.

Variable life policies come with added flexibility in the long term, but their death benefits simply won’t compete with term life coverage.

Limited Control Over Investments

Yes, you can invest your variable life policy’s cash value, but you have to invest within the parameters set up by your insurance company.

Some companies give you several — or even a dozen — choices for sub-accounts, but this hardly compares with the choices you’ll have when buying ETF or mutual fund shares online or through a brokerage.

Potential for Loss

As with any investment, your invested variable life insurance cash could lose value. A standard whole life policy can guarantee a specific rate of return, just like a savings account.

Caps on Gains

Even if your variable life sub-accounts grow significantly in value, many insurance companies cap your gains at a certain percentage per year.

They do this to keep your cash value from growing too quickly, upsetting the balance between your death benefit, your premiums, and your policy’s accrued value.

Increasing Premiums

If the market tanks like it did back in 2008, zapping your invested life insurance cash value, your insurer may increase your premiums to compensate for this lost value.

Many variable life policyholders experienced this worst-case scenario in late 2008 and 2009.

Can’t Simply Withdraw Money

A lot of insurance salespeople play up the comparison between variable life and an IRA, and the facts play this out to a certain degree.

But unlike an IRA during retirement, you can’t directly access money tied up in your insurance policy. You’d have to surrender the policy to receive the cash. Or, you could borrow against the policy’s value. Both of these solutions require various fees.

Investing Fees

The invested sub-accounts of your variable life insurance cash value have to be managed, and you’ll pay fees for this service.

A lot of policyholders don’t feel these fees because the insurance company withdraws them from your cash value. Over time, however, the fees can take a noticeable cut from your policy’s value, especially if the economy goes through a recession, and your cash value doesn’t grow.

Within the first decade of policy ownership, you’d spend more on fees than you’d earn on returns if you tried to redeem the policy’s cash value.

Variable Life Insurance Pros & Cons

Here’s a summarized list of the advantages and disadvantages of variable life insurance:

Pros

  • Elements of the Policy Interact
  • Potential for Faster Cash Value Growth
  • Tax Advantages

Cons

  • More Expensive & Less Coverage than Term
  • Limited Control Over Investments & Caps on Gains
  • Potential for Loss
  • Increasing Premiums
  • Can’t Easily Withdraw Money
  • Investing Fees

Do I Need Variable Life Insurance?

The list of variable life insurance cons goes on and on — high fees, slow growth, cumbersome access to the policy’s cash value, and so on.

Which begs the question: With all these weaknesses, who is the ideal candidate for variable life insurance?

Here’s the answer:

Someone who has a specific and long-term need for the tax advantages that variable life provides should consider it. Or, someone who wants his or her life insurance premiums to eventually become invested money rather than just money paid to reserve coverage.

Your financial advisor will be best positioned to help you determine how a variable life policy could work best for you.

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Who Doesn’t Need Variable Life Insurance?

This is an easier question to answer.

Someone who wants an affordable life insurance policy in case the worst happens does not need a variable life policy.

If this describes you, buy a term life policy with enough coverage to provide for your family for a decade or more. Term life can give you this kind of coverage with significantly lower premiums.

Then, with coverage in place to protect your family, you can begin your investing adventure independent of your life insurance policy.

Keeping your life insurance and your investments separate can provide the most financial freedom.

Grant Sabatier

Grant Sabatier

Creator of Millennial Money and Author of Financial Freedom (Penguin Random House). Dubbed "The Millennial Millionaire" by CNBC, Grant went from $2.26 to over $1 million in 5 years, reaching financial independence at age 30. Grant has been featured in The New York Times, Wall Street Journal, BBC, NPR, Money Magazine and many others. He uses Personal Capital to manage his money in 10 minutes a month.
Grant Sabatier

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