Variable life insurance provides a death benefit and an investment component. Unlike traditional life insurance, variable life insurance allows policyholders to invest their premiums. Start a search today to find affordable variable life insurance.
Understanding the importance of variable life insurance is crucial in comprehensive financial planning. It affords policyholders the flexibility to adjust their investment choices as their financial goals and risk tolerance evolve over time.
Understanding Variable Life Insurance Policies
In traditional life insurance policies, a consistent monthly premium is paid, and upon the policyholder’s death, beneficiaries receive a predetermined death benefit. Variable life insurance policies, however, offer more versatility. They allow for variable premium payments and enable policyholders to direct a portion of their premiums toward various investment opportunities for their own benefit.
At its core, a variable life insurance policy comprises two elements — a fixed death benefit and a cash value account. The death benefit functions similarly to that of term life insurance, providing a set payout upon the policyholder’s death. The real difference lies in the cash value aspect. In this setup, a part of the policyholder’s premium contributes to a cash value account, which they can invest across a range of options provided by the policy. This aspect is comparable to the workings of a typical 401(k) plan, with the flexibility to shift funds between different investment choices.
Understanding the Two Components
The best way to grasp the mechanism of variable life insurance is to envision it as combining life insurance with an investment account, exclusively linked to the premiums and payouts of the life insurance. Initially, contributions are made to both the life insurance and the investment account.
When the investment account performs well, its gains can be utilized to cover a portion of the life insurance premiums, although one can also continue to pay these separately, allowing the investment account to grow further. In the event of the policyholder’s death, the investment account is liquidated, and its remaining balance is paid out to the beneficiaries along with the death benefit.
Investment Potential of Variable Life Insurance
One of the most significant features of variable life insurance is its investment potential. Unlike traditional life insurance, where the focus is solely on the death benefit, variable life insurance introduces an investment angle that can be both rewarding and risky. The policyholder’s cash value is invested in a variety of funds, akin to a portfolio of stocks, bonds, or mutual funds. This setup provides the potential for higher returns compared to traditional life insurance policies.
Advantages of Variable Life Insurance
Variable life insurance, a form of permanent life insurance, offers the potential to pay for a limited time, accumulate substantial cash value through robust investment returns, and then use these accumulations to sustain a life insurance policy for life. Additional benefits include:
- Flexibility: The variable nature of the monthly premiums offers numerous advantages. You might find yourself paying for a set period and then enjoying a lifelong policy without additional costs. This flexibility is also beneficial in scenarios like financial downturns or large expenses, where you might need to reduce your payments. Ensuring a substantial built-up cash value can offset reduced payments.
- Tax Benefits: The cash value in variable life insurance policies grows tax-free, providing a significant advantage as it shields investment growth and payouts from annual taxes.
- Borrowing Options: It’s possible to borrow against the policy tax-free, with limitations. Typically, up to 95% of the cash value can be borrowed, subject to interest, offering a substantial liquidity option.
Drawbacks of Variable Life Insurance
Despite its benefits, variable life insurance has its complexities, especially when combining investment elements with a death benefit. Additional considerations include:
- Cost: The overall expense of such policies can be high, including initial sales and administrative fees, which affect the accumulation of cash value. Starting with a negative balance is a common occurrence.
- Fees: Investment management fees, similar to mutual fund expense ratios, vary and can be higher than standard brokerage accounts. Additionally, surrender charges may apply for up to 10-15 years, even if the policy is terminated early.
- Other charges: Various other fees must also be considered, underscoring the importance of thoroughly understanding the contract and discussing any queries with an insurance agent.
The Bottom Line
Variable life insurance policies are often debated. Many advocate for separate life insurance and investment accounts, especially considering the fees involved. However, the investment limitations of variable life insurance, typically to mutual funds without real-time updates or rapid trading, can be beneficial. These restrictions can prevent emotional trading, often detrimental to wealth accumulation. Ultimately, the choice between disciplined investment and the need for structured guidance is personal.