Variable Life Insurance: What It Is and How It Works

If you're in the market for a permanent life insurance policy, you may be considering variable life insurance. This form of permanent insurance offers a fixed death benefit, plus a cash value account that allows you to invest your equity in a variety of subaccounts and potentially grow your investment tax-deferred.

Read on for the ins and outs of variable life insurance, including how it works, potential benefits and drawbacks and key considerations to help you in deciding how well this type of life insurance might meet your needs.

What Is Variable Life Insurance?

When you're shopping for a life insurance policy, you can consider many types of life insurance. Variable life insurance is one form of permanent life insurance.

Length of Coverage

First, it's important to understand the differences between permanent and term life insurance. Permanent life insurance lasts for your entire life as long as you pay your premiums, while term life insurance covers a set period, while term life insurance is only lasts a certain period of time. That means your policy will pay out a death benefit to your beneficiaries no matter when you pass away.

Cash Value of Permanent Life Insurance

Permanent life insurance is generally more expensive than term life insurance, but it also provides additional benefits, including a cash value. With your plan's cash value, you can build equity over time as you pay premiums for your coverage. In contrast, with a term policy, your premium payments go toward pure protection with a set expiration date. If you die after your term coverage expires, your beneficiaries won't receive a death benefit. And term life insurance has no cash value available for you to access if needed.

Investing Your Cash Value

With a variable life insurance policy, additional potential benefits accompany your cash value component. You also have the option of investing your cash value into various investment options. The options, similar to mutual funds, are called "sub-accounts." Over time, you potentially can grow your investments in them tax-free.

It's important to understand, however, that the investments also come with the risk of loss. They potentially can lose value, depending on investment performance.

How Does Variable Life Insurance Work?

Just as with other types of life insurance, variable life insurance offers a death benefit that pays out to your beneficiaries when you die. But here are some few key differences set it apart:

• Choose how you invest the cash value among a menu of investment options. Your plan's cash value increases as you pay premiums over time — for example, if you pay a monthly premium of $400, your account's cash value would be around $4,800 after one year, minus any fees taken by the insurer.¹ The primary fee will always be for the cost of the protection itself.
• Choose how to invest your equity once you've built up the account's cash value. This is different from a whole life policy — another form of permanent life insurance. With a whole life policy, the insurance company determines how to invest your cash value, offering a potentially more modest return on your investment over time. With a variable life policy, you have more control over how your cash value is invested. Your investment options, as noted, are sub-accounts that typically invest in stocks, bonds and other variable instruments.²
• Option to invest your cash value in an account that pays a fixed rate of interest set by the insurance company. These earnings may be more modest than the potential ones from investments in stock- and bond-oriented subaccount options, but will also be more predictable and won't be subject to market volatility.

What Are Some Potential Benefits of Variable Life Insurance?

The primary benefit of variable life insurance, as with any type of life insurance, is the financial security provided to the beneficiary upon the insured's death.

Cash value life insurance, including variable life insurance, holds considerable appeal for people who prefer to establish lasting equity in their insurance policy, rather than paying premiums on a term policy that will never have a cash value. As long as you stay current on your variable life insurance plan's premiums, you can also rest assured that your death benefit will help provide for your beneficiaries, no matter when you pass away.

A key benefit of variable life insurance is the freedom to self-direct the investment of your account's cash value. For someone who's hands-on with their money and prefers to choose their investments, this is one potential advantage of a variable life policy versus other life insurance options. Other types of permanent life insurance generally offer less direct control over the account's investments. And, in exchange for accepting a greater degree of risk, if your investments perform well, you could potentially earn more money with a variable life insurance policy than you would from a whole life policy.

In addition, variable life insurance may come with some tax advantages. Earnings on the cash value of your account may grow tax-free, which means you only pay income tax on your earnings when you withdraw from the account. Your beneficiaries will not owe federal income tax on the death benefit paid out from your policy, either. For people with specific tax goals, investing the funds in a variable life policy could be more advantageous than investing their money elsewhere.

What Are the Potential Drawbacks of Variable Life Insurance?

Variable life insurance has some potential drawbacks, including higher expenses and more fees than other types of life insurance. Before securing a variable policy, be sure to inquire about the costs. These ultimately reduce your policy's cash value. Fees can also change over time. To gain a better understanding of what you should expect to pay, ask your financial professional or the insurer for more information about how account fees and policy costs are allocated.

A variable life insurance policy also isn't a tool for short-term savings. Ultimately, a life insurance policy exists to provide a death benefit to your beneficiaries at a time of need. If you're looking for an investment opportunity with a shorter horizon, work with a financial professional to consider different options.

Another important consideration: Any investment of your plan's cash value into a variable option comes with the risk of loss. Depending on investment performance, you could lose money from a variable life insurance policy. If that is a drawback for you, consider working with a financial professional to find a better option.

And even though tax rules on a variable life policy can be favorable for some people, there are many different tax rules that apply to these policies. The taxation on the account may not be favorable in your specific situation. Make sure to understand a policy's tax treatment in detail before purchasing a new plan.

Finally, permanent life insurance — including variable life insurance policies — costs more than term life insurance. For some people, the higher premium on a variable life insurance policy doesn't suit their monthly budget.

How Much Does a Variable Life Insurance Policy Cost?

Premium rates for variable life insurance vary based on your gender, age, lifestyle considerations (such as smoking), family health history, your occupation, the death benefit amount and many other personal factors.

Premiums for permanent life insurance policies tend to be higher than premiums for term life insurance. Variable life insurance premiums also tend to be higher than whole life insurance premiums due to the extra fees associated with managing your investments.

The best way to learn how much a variable life insurance policy costs is to reach out to a financial professional. They can help you gather variable life insurance quotes tailored to you and your unique needs and considerations.

Is Variable Life Insurance a Good Choice for You?

Variable life insurance isn't a good option for everyone. But could it be the right choice for you?

Here are a few reasons you may wish to purchase a variable life insurance policy:

• You prefer a permanent life insurance policy over a term policy. A permanent life insurance policy, including whole life and variable insurance policies, is designed to last your whole life as your premiums are paid. That means your beneficiaries will receive a death benefit regardless of when you pass away. This provides greater confidence compared to a term policy, which expires after a certain amount of time. Permanent life insurance also has a cash value. Term life insurance policies do not.
• You're looking for a long-term growth opportunity. Variable life insurance policies aren't for short-term investing, but if you're seeking an opportunity with a longer horizon, this type of policy may address your financial goals. Whole life insurance policies such as variable life insurance can provide a cash value as you pay your premiums, unlike term life insurance, which eventually expires and provides no cash value.
• You're a hands-on investor. Do you like to direct your own investments and maintain an active role in managing your financial portfolio? A variable life insurance policy can give you the freedom to invest among a range of sub-account options that work much like mutual funds. You may also have the option to invest in a fixed account that offers a fixed rate of interest set by your insurance provider.
• You're seeking tax benefits on your investments. Variable life insurance policies can provide some tax benefits, including tax-free growth on your investments. Make sure you understand your specific plan's tax treatment before purchasing a variable life insurance policy — the taxation may not be advantageous in your particular situation.

Footnotes and Sources

1. This is merely a hypothetical example to help readers understand how cash value works.
2. Variable Life Insurance. https://www.investor.gov/introduction-investing/investing-basics/investment-products/insurance-products/variable-life.