What is Variable Life Insurance

Like all permanent life insurance products, variable life insurance policies have two separate parts: The death benefit amount that is paid to the beneficiary or beneficiaries when the policyholder dies and the cash account into which the amount earned on the investment are credited while he or she is alive.

A variable life policy can have either a whole life policy or a universal policy as the underlying insurance. Variable is used to describe the policy because the cash portion can be invested in a combination of financial investment accounts that act like mutual funds. Investments are made at the direction of the policyholder, not by the insurance company. The owner of a variable life insurance policy is solely responsible for the investment decisions and allocation of the assets.

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What Are the Investments Available for Variable Life Insurance

Policyholders can often choose among a number of investment options. Some insurance companies offer over 50 different investments types. Depending on the life insurance company selling the policy, options can be low risk to high risk, or from extremely conservative to extremely aggressive. Options are also available for domestic and overseas funds.

Again, it is important to point out that the policyholder alone is responsible for determining how the money will be invested. The insurance company only purchases the shares and prepares the paperwork and statements. All gains in the account are subject to management fees and expenses.

No amount of the premium invested for the policyholder is intermingled in any of the insurance company’s accounts. Positive returns are never guaranteed and the value of the account can rise and fall with market conditions. Policyholders are urged to understand that universal life insurance is a financial product that is monitored by the Securities and Exchange Commission (SEC). In addition, all insurance agents who sell universal life policies must be licensed to sell both insurance and securities.

Some universal policies allow the owner to choose a fixed or variable death benefit. If choosing a fixed death benefit, the amount paid to upon the death of the policyholder remains the same, regardless of any increases or decreases in the cash value of the policy. A variable death benefit, however, will vary the amount paid to the beneficiary based on the value of the account.

Before choosing either option, investors are strongly urged to consider whether they need a variable policy to act more as an insurance product or more as an investment product. A reduced death benefit could mean a decreased standard of living, or worse, for the beneficiary.

What is a Variable Universal Life Insurance Policy

A variable universal life policy premium is flexible, as is the premium paid for a more traditional universal life plan. A policyholder can adjust both the amount of the premium and the payment schedule in order to accommodate current financial demands. He or she can reduce the amount of the payment if a sudden illness, job loss or other financial issue affects how much cash is available for the premium payment. This can, however, reduce the amount of cash value that has accrued in the policy. But it can be a way for the policyholder to ensure the policy remains in effect.

One disadvantage of a variable universal life insurance policy is that a significant market downturn can reduce the value of the cash account and the death benefit. Much like a margin call that can happen on a stock, a policyholder can be asked to contribute additional premium payments to keep the value level.

What is the Suitability for a Variable Life Insurance Policy

Variable life insurance policies are generally more suitable for people who can afford above average risk or those families that can withstand a reduced death benefit. While universal and whole life insurance policies can be good investments if used as a college savings plan, a variable policy is usually not. Even though it has cash value that might increase, the investments can lose money.

If the investments are not chosen well, the policyholder risks losing all or part of the investment. He or she may not be able to replace the losses in time. In addition, the cost of the insurance component of a variable policy is more expensive than standard whole life or universal life policies.

The cash account of a variable life insurance policy grows tax-deferred.  Earnings, therefore, compound faster in less time. A policyholder does not usually pay federal or state income tax on any money that is borrowed from the policy. Cash can typically be withdrawn up to the value of the premiums that have been paid over the life of the policy.

Because a variable policy is also a life insurance product, the cash account and the money earned on it, is not usually taxable in most circumstances. This means a policyholder can reduce his or her current year taxable income. And, because the death benefit paid to the beneficiary is not taxed, dollars can be placed in a child’s variable life policy. This allows parents to pass a tax-free inheritance to children.

Variable life insurance plans are considered securities and are therefore not insured by the Federal Deposit Insurance Corporation (FDIC). An insurance company selling a variable policy must be a member of the Securities Investor Protection Corporation (SIPC). The SIPC restores assets to investors who have lost account value in bankrupt or otherwise financially hobbled companies.

Because of the significantly higher premiums charged for other kinds of permanent life insurance and the potential for loss of value of the death benefit, the lapse rate of variable life investment policies is higher than normal. Almost all insurance agents believe that suitability for this type of insurance/investment product lies primarily with wealthier individuals with additional liquid assets.

Variable life insurance policies are very complicated insurance and investment products. Investors are always advised to make sure they speak with an experienced financial planner prior to purchasing a variable policy so that they understand the risks involved.

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