Guide to Variable Life Insurance
Variable life insurance combines permanent life coverage with investment opportunities, allowing policyholders to allocate portions of their premiums to market-based sub-accounts. Though less common than term life insurance, variable products make up roughly 12% of all life insurance premiums sold in the U.S., attracting investors seeking both protection and growth.
Unlike traditional policies with fixed returns, variable life offers potential for greater growth but also introduces investment risk, with performance typically reflecting broader market conditions.
Let’s start with the basics of how variable life insurance works and what makes it different from other standard life insurance policies.
What Is Variable Life Insurance?
Variable life insurance is a permanent life insurance policy that includes both a death benefit and an investment account.
When you pay your premium, some of that money covers insurance costs and fees. The rest goes into an investment account where you can choose various investment options similar to mutual funds. These might include stock funds, bond funds, or money market funds, depending on what your insurance company offers.
How well your investments perform directly affects your policy’s value. Good market performance can grow your money, but market downturns can shrink it. In some cases, poor performance might even reduce your death benefit if things go badly.
Variable Life vs. Variable Universal Life (VUL)
While often discussed as a single category, variable life and variable universal life are distinct products with important differences that can significantly affect how they work for you.
Variable Life Insurance:
- Fixed premium payments over the life of the policy
- More death benefit guarantees
- Less premium flexibility
- Suitable for those who prefer consistency in payments
Variable Universal Life Insurance (VUL):
- Flexible premium payments that can be adjusted
- Adjustable death benefit (can be increased or decreased)
- No guaranteed death benefit unless you pay an additional fee
- More popular today than traditional variable life
- Potentially higher risk if premiums aren’t maintained
Both types let you invest your money, but VUL gives you more flexibility with payments and benefits. That’s why it’s more commonly offered these days.
Key Features of Variable Life Insurance
Here are the main things that make variable life insurance stand out from other types of policies.
Permanent Coverage
As long as you keep paying your premiums, variable life insurance covers you for your entire life. There’s no expiration date like with term insurance.
Cash Value Tied to Market Performance
Unlike whole life insurance that guarantees a modest return, the cash value in a variable policy changes with the market. This means better growth potential but also the risk of losing money during market downturns.
Premium Allocation
Your premium payments get split three ways:
- Insurance costs (paying for the death benefit)
- Policy fees and expenses
- Investment portion (cash value)
As you get older, more of your premium typically goes toward insurance costs.
Investment Sub-Accounts
Sub-accounts are similar to mutual funds but exist exclusively within your insurance policy. You can choose to allocate your cash value across different funds based on your goals and risk tolerance. Some insurers offer dozens of options, while others may provide only a few.
Growth of Cash Value Over Time
The cash value can grow based on how your investments perform. There’s no cap on gains but also typically no floor, which means you could lose value during market downturns. Some policies may offer optional riders that provide minimum guarantees at an additional cost.
Tax Advantages
Variable life insurance offers several tax benefits:
- Cash value grows tax-deferred
- Death benefits are generally income tax-free to beneficiaries
- Policy loans against cash value can provide tax-free income (as long as the policy remains in force)
- Potential for tax-advantaged wealth transfer
What Happens at Death
Your beneficiaries will receive the death benefit stated in your policy. In some cases, the insurer may also pass along any accumulated cash value. Other policies only pay the death benefit and retain the cash value, so it’s important to understand your specific policy terms.
Fee Structure of Variable Life Insurance
Variable life insurance comes with several types of fees that affect your returns. It’s important to understand what you’re paying for.
Insurance Charges
- Cost of the death benefit itself
- These go up as you get older
Administrative Fees
- Monthly or annual policy fees
- Record-keeping costs
Investment Management Fees
- Similar to what you’d pay in mutual funds
- Usually between 0.5% to 2% of your investment amount
Surrender Charges
- Fees for canceling or withdrawing from the policy early
- These typically decrease over 10-15 years
Rider Costs
- Extra fees for additional benefits
- Examples include guaranteed minimum death benefits or long-term care benefits
All these fees add up over time and can significantly reduce what you earn compared to investing directly in similar funds outside an insurance policy.
Pros of Variable Life Insurance
Variable life insurance offers several potential advantages over other insurance types. These benefits primarily appeal to those seeking both protection and investment opportunities in a single financial product.
Potential for Higher Cash Value Growth
If your sub-accounts perform well, your policy’s cash value can grow faster than with traditional whole or universal life insurance.
Lifetime Coverage
As a form of permanent life insurance, variable policies provide coverage for your entire life, no expiration date, as long as the policy stays funded.
Tax-Deferred Investment Growth
Like a retirement account, your investment gains grow tax-deferred, which means you won’t pay taxes on growth within the policy. Policy loans can potentially provide tax-free income.
Flexibility and Control Over Investment Allocations
You get to decide how your money is invested within the policy, giving you the ability to align it with your broader financial goals and risk tolerance.
Cons of Variable Life Insurance
While variable life insurance offers unique benefits, it also comes with significant drawbacks that consumers should carefully consider before purchasing a policy. These disadvantages may outweigh the benefits for many potential buyers.
Risk of Losing Cash Value Based on Market Performance
The market goes up and down, and so will your policy’s cash value. Unlike whole life insurance, there are typically no guarantees on investment returns, meaning you could lose a substantial portion of your cash value during market downturns.
Higher Fees and Complexity
These policies often come with layered fees: administrative costs, investment management fees, mortality charges, and potential surrender charges. The combined cost can significantly diminish returns compared to other investment vehicles.
Potential for Reduced Death Benefit
If your investments underperform and your cash value shrinks too much, your death benefit could be at risk, especially if premiums aren’t maintained or if you’ve taken loans against the policy.
May Require Active Policy Management
Variable life insurance isn’t a “set it and forget it” product. You’ll need to monitor investment performance and possibly make adjustments to keep the policy on track with your goals.
Variable Life Insurance vs. Other Life Insurance Types
Comparing variable life insurance with other policy types helps clarify its unique position in the insurance market. This comparison allows you to see how variable life stacks up against alternatives across important features.
| Feature | Term Life | Whole Life | Universal Life | Variable Life | Variable Universal Life |
| Coverage Duration | Fixed term (10-30 years) | Lifetime | Lifetime | Lifetime | Lifetime |
| Cash Value | No | Yes (guaranteed) | Yes (minimum guaranteed rate) | Yes (market-based) | Yes (market-based) |
| Investment Component | No | No | Limited | Yes | Yes |
| Risk Level | Low | Low | Moderate | High | High |
| Premium Flexibility | No | No | Yes | No | Yes |
| Fees | Lowest | Moderate | Moderate | High | High |
| Policy Management | Simple | Simple | Moderate | Complex | Complex |
When Variable Life Makes More Sense
Not everyone needs or benefits from variable life insurance. However, certain financial situations and investor profiles make these products more suitable. Consider these scenarios where variable life might align with your needs.
Want to combine life insurance with investment potential
If you’ve maxed out other tax-advantaged accounts like 401(k)s and IRAs, variable life can offer another tax-deferred investment vehicle.
Have a long time horizon
The policy needs time to potentially overcome the high initial fees and grow, making it better for those with decades before needing access to cash value.
Are comfortable with market risk
If you already invest in the stock market and understand the volatility, you may be better prepared for the ups and downs of variable life sub-accounts.
Want greater control over their policy’s growth
Those who enjoy selecting and managing investments may appreciate the ability to direct their cash value allocations.
Who Should Consider Variable Life Insurance?
Specific demographic and financial profiles tend to benefit most from variable life insurance. Understanding these typical policyholder characteristics can help you determine if you fit the profile.
Investors Comfortable With Market Risk
If you’re already investing in the stock market and understand the risks, variable life could fit your strategy.
High-Income Earners Seeking Tax-Deferred Growth
Once you’ve maxed out 401(k)s and IRAs, a variable life policy offers another vehicle for tax-advantaged growth.
Individuals With Long-Term Estate Planning Goals
The lifelong death benefit can play a key role in transferring wealth to heirs, especially for those with large estates or business succession plans.
How to Choose a Variable Life Insurance Policy
If you’ve decided variable life insurance might be right for you, the next step is selecting the right policy. These key factors should guide your evaluation process when comparing different options.
Premium Structure
Can you afford the premiums now and in the future? For VUL policies, does the policy allow flexible contributions when needed?
Investment Options and Performance
Look at the variety, past performance, and risk level of the sub-accounts offered by the insurer. More options generally provide better diversification opportunities.
Policy Illustrations and Projections
Insurance companies provide illustrations showing how the policy might perform under various scenarios. Remember that these are projections, not guarantees. Be wary of illustrations showing unrealistically high returns.
Fees and Expenses
Understand all costs involved: mortality charges, admin fees, fund expenses, and surrender charges can significantly impact returns. Compare these across different policies.
“Look Period” Provisions
Most policies offer a “free look” period (typically 10-30 days) during which you can cancel without penalty. Understand these terms before committing.
Financial Strength of the Insurer
Choose a financially sound company. Look for high ratings from agencies like AM Best, Moody’s, or S&P. Since variable life is a long-term commitment, you want an insurer that will remain stable for decades.
Regulatory Considerations
Variable life insurance faces stricter regulatory oversight than traditional life insurance policies due to its investment components. These regulations provide important consumer protections but also add layers of complexity.
- Variable policies are considered securities products
- They’re regulated by both state insurance commissioners and the Securities and Exchange Commission (SEC)
- Insurance agents selling these products must have proper securities licenses in addition to insurance licenses
- Insurers must provide prospectuses detailing all policy charges, fees, and sub-account expenses
This additional regulation provides more disclosure but also contributes to the product’s complexity.
Working With a Financial Professional
The complexity of variable life insurance makes professional guidance particularly valuable. Finding the right advisor can help you navigate these sophisticated products effectively.
- Work with a fee-only financial advisor who can objectively evaluate whether this product fits your overall financial strategy
- Consult with a tax professional regarding potential tax implications
- Understand how your financial professional is compensated for selling the policy
Be wary of advisors who recommend variable life insurance without thoroughly analyzing your financial situation, goals, and risk tolerance.
Alternatives to Variable Life Insurance
For many consumers, other financial products may better meet their needs than variable life insurance. Understanding these alternatives helps you consider all options before making a decision.
Term life insurance
Provides death benefit protection for a specific period (10-30 years) with much lower premiums. Consider “buy term and invest the difference” as a strategy if your primary goal is investment growth alongside protection.
Whole life insurance
Another permanent policy with cash value that grows at a low but guaranteed rate. Offers more predictability but less growth potential than variable options.
Universal life insurance
Blends elements of whole life’s stability with some of variable life’s flexibility. Offers lifelong coverage with a fixed or indexed growth component for cash value and adjustable premiums.
Indexed universal life insurance
Similar to universal life but ties cash value growth to market indexes like the S&P 500, usually with caps on gains but also floors protecting against losses.
Separate investment accounts
Consider keeping life insurance and investments separate through term life insurance combined with traditional investment accounts or retirement plans.
FAQs
Can I convert my existing life insurance policy to a variable life policy?
This depends on your current policy. Some term policies include conversion options to permanent insurance, but specifically to variable life is less common. Converting usually requires paying higher premiums but often doesn’t require a new medical exam. Check your policy for conversion provisions or speak with your insurer about available options.
How are variable life insurance policies treated in divorce proceedings?
Variable life policies are generally considered marital assets if purchased during marriage. The cash value may be subject to division in a divorce settlement. Some couples address this specifically in prenuptial agreements. The beneficiary designation can be changed during divorce proceedings, but court orders may restrict this in some cases.
What happens if I become disabled and can’t pay the premiums?
Without a disability waiver rider, your policy could lapse if premiums aren’t paid. Many insurers offer optional disability waiver riders that continue premium payments if you become disabled. This rider adds to the policy cost but provides important protection, especially for policies with substantial premiums.
Can I use variable life insurance for business purposes?
Yes, variable life insurance can be used for business purposes such as key person insurance, funding buy-sell agreements, or executive benefits. The investment component can make it attractive for business succession planning. However, business-owned life insurance has specific tax rules and reporting requirements that differ from personally-owned policies.
Conclusion
Variable life insurance offers permanent coverage and the potential for investment-driven growth—but that also comes with greater complexity and risk. It works well for some people but isn’t right for everyone.
If you’re considering life insurance as part of a broader wealth-building and protection strategy and want the flexibility to grow your policy’s value through market investments, variable life insurance may be worth exploring.
Next step? Speak with a qualified financial advisor who can analyze your specific situation and help determine if a variable life insurance policy aligns with your financial goals and risk tolerance. Given the complexity of these products, professional guidance is essential rather than optional.