How Variable Life Insurance Works: Pros and Cons – ValuePenguin

Variable life insurance policies have higher cash-earning potential than other permanent life insurance policies. With variable life insurance, you can decide how to invest the cash value. however, variable life insurance policies often have higher rates than other cash value life insurance policies.

what is variable life insurance?

Variable life insurance is a type of permanent life insurance policy, meaning the coverage will remain in force for life as long as premiums are paid.

Reading: How does variable life insurance work

every variable life insurance policy has three main components:

A death benefit is what is left to your beneficiaries. Every time you make a premium payment, a portion goes toward the cost of insurance and insurer fees, which maintain the death benefit. the remainder of the premium goes toward the cash value of the policy, which is structured similarly to a brokerage account. the cash value can be invested in certain securities (often called subaccounts) that resemble mutual funds.

If the cash value performs well, it can be used to increase a death benefit, withdrawn as cash, or used as collateral for a loan.

Cash value is also the amount of money you would receive if you chose to assign or surrender your coverage to the insurer.

cash value of variable life insurance

The cash operation of a variable life insurance policy is unique compared to an index or whole universal life insurance policy. Each variable life policy comes with a prospectus detailing about 20 to 30 options to invest the cash value in, and cash value investment options are similar to mutual funds in that there is a particular set of securities in which the money would be invested, like:

Variable life insurance policies generally also offer a fixed-rate investment option provided by the insurer. however, regardless of the option you choose, you will be charged administration fees, similar to mutual fund expense fees. these fees vary depending on the securities invested in and can be quite high if the money is actively invested (meaning a portfolio manager is choosing stocks).


Cash value investment management fees are sometimes listed as “basis points” with one basis point equaling 0.01%.

This means that if an investment option is listed with a 6% historical rate of return but comes with 125 basis points in management fees, you should be aware that the returns will be reduced by 1.25%.

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Because you can choose from a variety of investment options, variable life insurance policies have greater growth potential than other cash value policies, such as whole life insurance.

however, variable life insurance policies may not have a guaranteed rate of return or may be quite low. In addition, your cash value investment options are generally capped at the maximum rate of return. Your cash value may actually decline during bad years and may not perform as well as it would during good years.

a key disadvantage of variable life insurance

All permanent life insurance policies come with rates, but the downside of variable life insurance is that it tends to have the highest. Variable life insurance policies will typically have the following costs:

other costs and risks

Administrative fees for a variable life insurance policy will be higher than for other life insurance policies, in part because these policies are safety-regulated investments. You should keep in mind that the insurer will pass these charges on to you when determining how to invest the policy’s cash value.

For example, if you choose relatively conservative investments, you’re likely to realize returns more like the cash value of a life insurance policy. however, if you purchased whole life insurance, you pay lower rates. therefore, at the same cash value rate of return, you would actually do worse with a variable life insurance policy.

variable life insurance death benefit

The death benefit of a variable life insurance policy is generally structured in one of two ways:

Regardless of the structure of your death benefit, you should always check the actual terms of the policy. and you must confirm whether the death benefit is guaranteed and, if so, whether the guaranteed value is the same as the projected value.

The death benefit is essentially a “target” using a cash value performance assumption, such as a 4% annual rate of return. The insurer projects that, assuming you meet this rate of return, the cash value would be equal to the face value of the policy when you die. however, if your cash value is significantly underperforming, it may reduce your actual death benefit, depending on the terms of your policy.

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Flexible premiums with variable universal life insurance

Variable universal life insurance policies have the cash value structure of variable life insurance, but you can use the cash value to pay premiums. You can also pay a higher amount in premiums if you choose to do so. therefore, these policies are sometimes referred to as flexible premium variable life insurance.

While variable universal life insurance policies typically have minimum and maximum premiums, you can pay any amount you choose that falls within these limits. this means you can:

There are also single-premium variable universal life insurance policies that allow you to purchase coverage and finance the cash value of the policy with a single payment. Basically, you buy coverage and make all the required cash value contributions at once. but you also have the option to contribute more to the policy’s cash value if you choose to do so.

how variable life insurance compares to other products

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If you’re considering variable life insurance, it’s important to consider how this policy compares to similar financial products. A variable annuity is just a tax-deferred annuity where you get to choose how the value of the annuity is invested. It is somewhat similar to a variable life insurance policy in that:

variable annuity versus variable life insurance

The main difference between a variable annuity and variable life insurance is that with the former you will receive your investment in a series of payments from the insurer. With the latter, you can make a series of withdrawals of the policy’s cash value, make a single large withdrawal, or simply use the cash value as collateral in a policy loan.

Variable annuities are also restricted in that you may have to pay a fee to make withdrawals before a certain age. Withdrawals from variable life insurance policies are only restricted by the amount of cash value available.

variable life insurance versus whole life insurance

both variable life and whole life insurance. offer lifetime coverage, but whole life insurance policies offer lower risk and reward.

whole life insurance policies have:

The cash value of variable life insurance policies can grow at a much faster rate and, in certain cases, can be used to pay premiums. whole life insurance policies don’t offer the flexible premiums of variable universal life insurance policies.

variable life insurance vs. mutual funds and term life insurance

“Buy term and invest the difference” is a phrase often used to discourage people from purchasing cash value life insurance policies, such as variable life insurance. If your financial obligations are likely to be gone in 20 to 30 years, then buying term life insurance is probably a better option, as it’s significantly less expensive than variable life insurance.

For example, if you’re buying life insurance to make sure your family can stay in your home if you die and you have a 15-year mortgage, you’d be better off with term life insurance. Similarly, if you could save enough money over the next two decades to handle any future financial obligations, you should go ahead and simply purchase temporary coverage as backup. With variable life insurance, you’re paying more to have a death benefit for your lifetime. Otherwise, you can simply purchase guaranteed universal life insurance and invest the difference in mutual funds or ETFs.

continue adding to your retirement fund

There are pros and cons to both options, but we’d typically recommend maximizing contributions to retirement accounts before investing in variable life insurance.

With a 401(k) or IRA plan, your money will grow tax-deferred and you’ll have a wider variety of investment options with lower fees. the only drawback is that it will be more difficult to access your money over a period of time, but even variable life insurance policies have surrender and withdrawal fees.

Assuming your retirement accounts are fully funded, then whether to put your money in a brokerage account or a variable life insurance policy depends on how you think the variable policy’s investment options will perform. tax-deferred growth can offset moderate management fees if your cash value works well enough, but you need to assess the expected return for yourself.

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