Life insurance provides protection for your family and offers financial peace of mind should you pass away unexpectedly. It comes in two primary types: permanent life insurance, which provides coverage your entire lifetime, and term life insurance, which lasts for a predetermined period of time.
Permanent life insurance comes in many different shapes and forms, but all carry similar features related to lifelong death benefit coverage and some cash value component, which can build with time.
One type of permanent insurance is variable life insurance, which gives you the ability to invest in assets like stocks, bonds and mutual funds through subaccounts in the policy. The returns aren't guaranteed for you, but they can have higher potential upsides than cash value schemes in other types of permanent life insurance policies. Read on to learn more about variable life insurance policies, how they work, whether they're a good fit for you and what to look for.
What Is Permanent Life Insurance?
The term "permanent life insurance" says it all: It's life insurance that stays with you for your entire life — so long as you stay current on your premiums. This compares to term life insurance policies, which only last for a specified period of time before expiring.
Further, most types of permanent life insurance offer a cash value, which can grow over time. There are four types of permanent life insurance: whole, universal, variable and variable universal.
Whole life insurance provides three guarantees for policyholders:
- A death benefit to cover your entire lifetime.
- An associated savings component, which can grow at guaranteed rates and build a cash value over time.
- Policy premiums, which won't go up over time.
Variable and universal share similar characteristics by also offering a lifetime death benefit, but they differ in how they allow you to build your savings value and the premium payment structures, respectively.
What Is Variable Life Insurance?
Variable life is a type of permanent life insurance that also comes with a cash value and a death benefit, which lasts your entire life. Variable life differs from whole life policies in that it offers investment options through subaccounts — with which you can invest in assets like stocks, bonds and mutual funds — as opposed to offering a guaranteed rate of return.
Because of this, your cash value can grow at different rates in accordance with the market performance of your underlying assets. Like traditional retirement accounts, earnings made in your cash value account grow tax-deferred and only trigger a tax liability on the earnings you withdraw.
How Does Variable Life Insurance Work?
Variable life policies offer permanent death benefits, which don't expire when you reach a certain age, as well as premiums you can put toward one or more separate investment accounts. You can have a large number of investment options to select from, including fixed-income securities, stocks, mutual funds, bonds and money market funds.
As you pay your premiums, a significant portion goes toward these investment accounts and can build your cash value if the underlying investments perform well. Most variable life policy issuers employ their own investment managers to supervise how your funds are invested in the accounts, resulting in asset management fees.
You want to monitor these fees as well as how your investments perform over time. Because you can invest in long-term assets like stocks and mutual funds, you may accumulate a larger cash value than you might under a whole life policy. However, because variable life returns are market-based and not guaranteed as they are in whole life policies, your cash value may underperform that of other permanent life insurance policies.
You can use your account earnings either to pay for your fixed premium payments or add them to your cash value. If your investments perform poorly, you might not have enough money to cover your premiums, and your death benefit may decrease. To guard against this unfortunate scenario, many insurers provide a guaranteed minimum death benefit.
How Does Variable Life Insurance Compare to Term Insurance?
Coverage and Costs
Coverage through variable life lasts longer and has no risk of expiring should you keep your premium payments current. Term insurance coverage expires after a certain number of years, which will be stated in your policy, leaving you without protection beyond a fixed time frame.
While you will lose your coverage after a period of time, insurance needs evolve over time with changes in your life and net worth. When you have young children with years of financial support ahead of them, carrying insurance coverage makes a lot of sense. With time, your needs should abate as your children become independent and you accumulate your own wealth to cover costs for remaining dependents. Variable life offers you the chance to retain lifelong coverage with the potential of an increasing cash value through investing in tax-deferred investment accounts.
While you pay for coverage under both policies, term life premiums only go toward the insurance, while variable life policies provide this for life and go toward investments, fees and expenses. Term life insurance can work as an excellent, low-cost way to provide financial security for people who depend on you while you build your wealth and amass your own financial protection through savings.
Likewise, variable life can invest a significant amount of your premiums into market-based investments that grow with time in a tax-deferred manner. If your investments perform well, you can use this growing cash value to pay premiums yourself or increase your death benefit.
The question of which option is right for you comes down to what your lifelong needs are and whether you expect them to change over time.
Financial Planning Options
Variable life gives you more financial planning options due to its market-based performance and ability to build a cash value and remain with you as long as you live. You should consider the investment options available to you through your variable life policy as well as the risks involved.
Comparing investments between different insurers isn't always an easy task. Make sure you understand how they compare by looking at the internal rate of return (IRR), a metric that measures the return at which your premium paid equals the net present value of the death benefit.
All things equal, higher IRRs increase the appeal of policies when comparison shopping.
When Is Variable Life Insurance a Good Fit?
Variable life provides you a lifelong death benefit and cash value, both of which can grow in line with the market performance of the investments held in your policy. You can typically choose two death benefit options: a set face value or a cash value, which equates to the face amount accumulated investments of your policy. The latter is typically a more expensive option.
This might be a good choice if you want the certainty of a death benefit with the ability to realize market-based returns in a tax-advantaged way. Just the same, you should be mindful of the policy's costs as these can reduce your gains. Further, the amount of risk you take with these policies depends on the investments you make.
If you know your insurance needs will decrease with time, a cheaper term life policy may provide enough coverage for most situations. It can offer the financial peace of mind you need at an affordable cost.
Variable life policies work well if you need coverage irrespective of when you pass away, wish to leave money to your beneficiaries and want to take advantage of tax-advantaged savings opportunities. In fact, if you've maxed out your retirement accounts and met your other financial needs, investing in a variable life policy might be wise for tax planning purposes.