The basics of variable life insurance
People who need permanent life insurance but want potentially higher cash values than those offered by whole life policies will often choose variable life or variable universal life insurance.
Variable life products provide a death benefit like other insurance policies, but unlike other options they allow you to invest your cash value in mutual-fund-like subaccounts. These subaccounts offer different investment options in stocks, bonds, money market funds, and other securities. The number and variety of subaccount options will vary by company.
The money in those subaccounts will increase or decrease over time, depending on their performance. You can typically transfer funds between investment options.
Variable policies come in two forms: traditional variable life and variable universal life. The main difference is that variable life is more akin to whole life policies, in that your premium payments and your death benefit are fixed for the life of the policy.
Variable Universal life, on the other hand, allows you to vary your premium payments as long as there exists enough cash value to support the policy. The death benefit can change over time, depending on the performance of the investments supporting the policy’s expenses.
Variable policies are more expensive than other types of permanent insurance. In addition to the cost of insurance and mortality charges, premiums must also cover the expense of the underlying investments funds.
Unlike whole, fixed, and indexed life policies, there is no cap on the amount of interest your cash value can earn in a given period. At the same time, there is no floor, so your cash value can decrease in value if your investments do not perform well. In essence, you’re taking on more risk in order to generate a higher return.
One risk that most insurance companies have eliminated is the risk of losing the death benefit due to poor investment performance. Early variable policies had no guarantees, so if investment performance depleted the policy’s cash value, the insured would either have to pay more premium or lose the insurance coverage. Today’s variable and variable UL policies offer a guaranteed death benefit, regardless of investment performance.
Like other types of cash value life insurance, variable policies provide the ability to access the cash value and use it for a variety of needs. Some people use their life insurance policy cash value to help fund a child’s college education, others use it for supplemental retirement income, and it can even be used for home improvement or medical expenses.
Variable life also offers the same tax-deferred growth as annuities and qualified retirement plans, meaning you do not have to pay taxes on the policy’s interest growth each year.
Life insurance also has special tax treatment that allows you under some circumstances to loan yourself part of your cash value without owing taxes on the proceeds. Depending on the provisions of your contract, you can often take as long as you wish to pay back the policy loan, or you can choose not to repay the loan and accept a lower death benefit. If you choose to repay the loan, you will often receive a more favorable interest rate than you would through traditional lenders, and the loaned funds will continue to earn interest as if they were never withdrawn.
Also, because life insurance withdrawals are not taxable, they don’t impact the formula the IRS uses to determine whether to tax your Social Security benefits.
At the same time, there are no IRS contribution limits on life insurance, so it’s potentially a way to save large sums on a tax-advantaged basis. Also, you don’t have to wait until you’re 59 1/2 to access the funds in your life insurance policy like you do for annuities and 401(k)s.
Variable life insurance is also fairly liquid. While most annuity contracts only allow you to withdraw 10 percent of the account value with a surrender charge, many life insurance policies allow you to withdraw up to 90 percent of the cash value.
And like most life insurance policies, a variable life insurance policy provides a tax-free death benefit to the beneficiaries.