Understanding Variable Life Insurance: What is it and how does it work?

Variable life insurance is a type of life insurance policy that provides both a death benefit and an investment component. It allows policyholders to allocate a portion of their premiums towards different investment options, such as stocks, bonds, or mutual funds. The cash value of the policy can fluctuate based on the performance of these investments.

What Is Variable Life Insurance?

Variable life insurance is a unique type of life insurance policy that combines the benefits of life insurance coverage with the opportunity for investment growth. Unlike traditional life insurance policies, which have a fixed premium amount and a predetermined death benefit, variable life insurance policies offer policyholders a level of flexibility and control over their policy.

Variable life insurance is a popular choice for individuals who are looking for both protection and potential investment growth. It allows policyholders to allocate a portion of their premium payments to different investment options, known as “sub-accounts.” These sub-accounts are usually comprised of mutual funds and provide policyholders with the opportunity to potentially earn a higher return on their investment.

One key feature of variable life insurance is that the cash value of the policy fluctuates based on the performance of the chosen investments. If the investments perform well, the cash value can increase, providing the policyholder with a greater potential for growth. However, if the investments perform poorly, the cash value may decrease, potentially affecting the policy’s cash value and death benefit.

Definition And Overview

Variable life insurance is a type of permanent life insurance that provides a death benefit to the beneficiaries upon the death of the insured. The policyholder has the ability to allocate a portion of their premium payments to different investment options, known as “sub-accounts.” These sub-accounts are usually comprised of mutual funds and allow the policyholder to potentially earn a higher return on their investment.

Read More: Accidental Death and Dismemberment Insurance: What It Is and How It Works

The flexibility and control offered by variable life insurance make it an attractive option for individuals who want to have a say in how their policy’s cash value is invested. By choosing different investment options, policyholders can tailor their policy to align with their risk tolerance and financial goals.

It’s important to note that variable life insurance is a long-term commitment. Policyholders should carefully consider their investment choices and regularly review their policy to ensure it remains aligned with their financial objectives.

Key Features And Benefits

Variable life insurance offers several key features and benefits that differentiate it from other types of life insurance policies. One of the main advantages is the potential for investment growth. The ability to allocate premiums towards different investment options allows policyholders to take advantage of market opportunities and potentially earn higher returns.

Additionally, variable life insurance policies provide a death benefit to the beneficiaries upon the death of the insured. This death benefit can be used to provide financial protection for loved ones, such as covering funeral expenses, paying off debts, or providing for ongoing living expenses.

Furthermore, variable life insurance policies offer policyholders the opportunity to access the cash value of their policy through policy loans or withdrawals. This can be beneficial in times of financial need or as a source of supplemental income during retirement.

It’s important to understand that the cash value of a variable life insurance policy is not guaranteed and can fluctuate based on the performance of the chosen investments. Policyholders should carefully monitor their policy’s performance and make adjustments as needed to ensure it remains on track to meet their financial goals.

Read More: How Life Insurance Dividends Work

Types Of Variable Life Insurance Policies

There are several types of variable life insurance policies available to suit different needs and preferences. The most common types include:

1. Variable Universal Life Insurance: This type of policy combines the flexibility of variable life insurance with the option to adjust the premium and death benefit amounts. Policyholders have the ability to modify these amounts based on their financial circumstances and goals.
2. Indexed Variable Life Insurance: This policy offers a death benefit that is tied to the performance of a specific market index, such as the S&P 500. The cash value of the policy can also be affected by the performance of the index, providing potential for growth. (For more information, read our “Understanding Indexed Universal Life Insurance”).
3. Survivorship Variable Life Insurance: This policy insures two individuals, usually spouses, and pays out the death benefit upon the death of the second insured. It is commonly used in estate planning to provide financial security for heirs or to cover estate taxes.

Read more:

• Understanding Indexed Whole Life Insurance
• What is a survivorship life insurance policy?

Each type of variable life insurance policy offers unique features and benefits. It’s important for individuals to carefully consider their financial goals and consult with a financial advisor to determine which type of policy is most suitable for their needs.

How Does Variable Life Insurance Work?

Now that we have explored what variable life insurance is, let’s dive into how it works and the key components of this type of policy.

Variable life insurance is a type of life insurance policy that offers policyholders the opportunity to invest a portion of their premiums into various investment options, such as stocks, bonds, or mutual funds. The cash value of the policy is directly tied to the performance of these investments, providing potential growth opportunities for policyholders.

Premiums And Policyholder Contributions

When it comes to variable life insurance, policyholders have the flexibility to choose the amount of their premiums and the frequency of their payments. These premium payments are used to cover the cost of insurance, administrative fees, and the investments within the policy.

It’s important to note that variable life insurance policies typically have higher premium requirements compared to other types of life insurance due to the investment component. This is because a portion of the premium is allocated towards the chosen investments, which can add to the overall cost of the policy.

Policyholders must carefully consider their financial situation and investment goals when determining the amount of their premiums. Higher premium payments may allow for greater investment opportunities and potential growth, but they also require a larger financial commitment.

Investment Component And Cash Value

One of the distinguishing features of variable life insurance is the investment component. Policyholders have the ability to allocate a portion of their premiums towards different investment options, such as stocks, bonds, or mutual funds. The cash value of the policy is directly tied to the performance of these investments.

It’s important for policyholders to carefully consider their investment choices, as the performance of the investments will impact the cash value of the policy. If the investments perform well, the cash value has the potential to increase, providing the policyholder with a greater opportunity for growth. On the other hand, if the investments perform poorly, the cash value may decrease, potentially affecting the policy’s cash value and death benefit.

Policyholders should regularly review and adjust their investment allocations based on their risk tolerance and market conditions. This allows for a more dynamic approach to managing the cash value of the policy and maximizing potential growth.

Death Benefit And Policy Options

Variable life insurance policies provide a death benefit to the beneficiaries upon the death of the insured. The amount of the death benefit is typically determined at the time of policy purchase and can be a fixed amount or a variable amount based on the policy’s cash value.

Policyholders have the option to choose additional policy features, such as riders or endorsements, which can enhance the policy’s coverage. These additional features may include accelerated death benefit riders, which allow for the early payout of a portion of the death benefit if the insured is diagnosed with a terminal illness.

It’s important for policyholders to carefully review and understand the terms and conditions of these additional policy features, as they may have certain limitations or exclusions. Consulting with a financial advisor or insurance professional can help policyholders make informed decisions about the options that best suit their needs.

Overall, variable life insurance offers policyholders the opportunity to combine life insurance protection with potential investment growth. By carefully managing their premiums, investment allocations, and policy options, policyholders can customize their coverage and potentially build cash value over time.

Read More: How Life Insurance Works: Understanding Your Coverage and Claims

Pros And Cons Of Variable Life Insurance

Like any financial product, variable life insurance has its advantages and disadvantages. Let’s explore the pros and cons to help you make an informed decision.

Advantages Of Variable Life Insurance

There are several advantages to consider when it comes to variable life insurance:

• Potential for Investment Growth: Variable life insurance allows policyholders to potentially earn higher returns on their investments, providing an opportunity for growth.
• Flexibility and Control: Policyholders have the ability to allocate their premiums towards different investment options, giving them a level of control over their policy.
• Tax Advantages: The cash value of a variable life insurance policy grows tax-deferred, meaning that policyholders do not have to pay taxes on the investment gains until they withdraw the funds.

One of the main advantages of variable life insurance is the potential for investment growth. Unlike other types of life insurance, variable life insurance allows policyholders to invest a portion of their premiums into various investment options. This means that the cash value of the policy can potentially grow over time, providing an opportunity for higher returns. This can be especially beneficial for individuals who have a higher risk tolerance and are looking to maximize their investment potential.

Another advantage of variable life insurance is the flexibility and control it offers. Policyholders have the ability to allocate their premiums towards different investment options, such as stocks, bonds, or mutual funds. This gives them the freedom to tailor their policy to their specific investment goals and risk tolerance. Additionally, policyholders can adjust their investment allocations over time as their financial situation or investment objectives change.

In addition to potential investment growth and flexibility, variable life insurance also offers tax advantages. The cash value of a variable life insurance policy grows tax-deferred, meaning that policyholders do not have to pay taxes on the investment gains until they withdraw the funds. This can be advantageous for individuals who are looking to build wealth over the long term and want to minimize their tax liability. (For more information, read our “What are the tax rules around life insurance?“).

Disadvantages Of Variable Life Insurance

While variable life insurance offers certain advantages, it’s important to consider the following disadvantages:

• Investment Risk: The performance of the chosen investments can impact the cash value of the policy. If the investments perform poorly, the cash value may decrease.
• Higher Premiums: Variable life insurance policies typically have higher premium requirements compared to other types of life insurance due to the investment component.
• Complexity: Variable life insurance policies can be more complex compared to other types of life insurance, requiring policyholders to be knowledgeable about investments and market conditions.

One of the main disadvantages of variable life insurance is the investment risk involved. Since the cash value of the policy is tied to the performance of the chosen investments, if the investments perform poorly, the cash value may decrease. This means that policyholders may not receive the expected returns and could potentially lose money. It’s important for individuals considering variable life insurance to carefully evaluate their risk tolerance and investment knowledge before committing to this type of policy.

Another disadvantage of variable life insurance is the higher premium requirements. Due to the investment component of variable life insurance, the premiums tend to be higher compared to other types of life insurance. This can make variable life insurance less affordable for some individuals, especially those who are on a tight budget or have other financial obligations to consider. It’s essential for individuals to carefully assess their financial situation and determine if they can comfortably afford the premiums associated with variable life insurance.

Lastly, variable life insurance policies can be more complex compared to other types of life insurance. Policyholders need to have a good understanding of investments and market conditions in order to make informed decisions regarding their policy. This complexity can make variable life insurance less suitable for individuals who are not comfortable with investment concepts or who prefer a more straightforward life insurance option. It’s important for individuals to carefully weigh the benefits and drawbacks of variable life insurance and determine if it aligns with their financial goals and level of investment knowledge.

Factors To Consider Before Purchasing Variable Life Insurance

Before purchasing a variable life insurance policy, it’s important to take into account certain factors to ensure it aligns with your financial goals and objectives. Here are some key considerations:

Risk Tolerance And Investment Knowledge

Variable life insurance policies involve investment risk, as the cash value is tied to the performance of investments. It’s important to assess your risk tolerance and investment knowledge before purchasing a variable life insurance policy. If you have a low risk tolerance or limited investment knowledge, a different type of life insurance policy may be more suitable.

Financial Goals And Objectives

Consider your financial goals and objectives when evaluating a variable life insurance policy. If your primary goal is to accumulate wealth and potential investment growth aligns with your objectives, variable life insurance may be a suitable option. However, if your primary goal is to provide financial protection for your loved ones and investment risk is a concern, a traditional life insurance policy may be more appropriate.

Policy Costs And Fees

Variable life insurance policies typically have higher premium requirements compared to other types of life insurance. In addition, policyholders should also consider the costs associated with the chosen investments, such as management fees or expense ratios. It’s important to thoroughly review the policy costs and fees to ensure they align with your budget and financial goals.

In conclusion, variable life insurance is a unique type of policy that offers both a death benefit and an investment component. It provides policyholders with the opportunity for potential investment growth but also carries certain risks and complexities. Before purchasing a variable life insurance policy, it’s essential to carefully consider your financial goals, risk tolerance, and investment knowledge to ensure it aligns with your needs and objectives.