Variable life insurance is a form of insurance that builds cash value. Of all the types of life insurance, it’s the only one that is regulated at the federal, not state, level. This is because variable life insurance is a hybrid insurance/investment product. Insurance agents and representatives who want to sell this product must obtain a license from their home state to sell insurance. In addition, they must also become registered brokers.
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How Variable Life Insurance Works
Like a universal life insurance policy, there are two parts of a variable life policy: the insurance and the investment fund. But the similarities end there. As the policyholder, you can choose which type of investment, like stocks, bonds and funds, you wish to invest in. Since these are securities-based investments, you must receive a prospectus before investing. As with all securities investments, you always take on the risk of some loss.
As a combined insurance and investment product, the earnings on your investments are not taxed until you surrender the policy. This differs from traditional investments. There, certain types of earnings (like dividends) are taxable in the year they are earned. You also have the option of applying interest and dividend earnings to your premiums. This means that when your investments are doing well, you have the potential to lower your premium payments dramatically.
Other Risks and Advantages of Variable Life Insurance
You have the ability to change your investments from one instrument to another, as permitted by your contract. You can base your decisions on current or anticipated performance. However, you will typically face some fees and expenses for each transaction you make. As the policyholder, you hold the responsibility of watching your investments’ performance. This means you will need at least a basic understanding of investing to succeed.
On the other hand, when your investments are doing poorly, you could face increased premiums. Then if you don’t pay your premiums, you could lose your life insurance. Some policies allow for a reduction in your coverage within predefined limits. However, you’re still left with less insurance than you may need.
Variable Universal Life Insurance
An alternative to a standard variable life policy is a variable universal life (VUL) insurance plan. This type of policy also allows you to invest in multiple types of securities. As an added benefit, you can choose your premium payment amounts. Plus, you can control how often you pay them, as you can with regular universal life insurance.
If your policy comes with death benefits, you can adjust those as well. Although, you could face a fee for reducing the amount of money your beneficiaries receive. All whole life policies, including VUL and variable life insurance, allow you to use a loan to borrow against the insurance policy. The cash value is tax-deferred, so you won’t owe taxes on it. It is taxable if you were to withdraw the funds later on but before it’s passed to your beneficiaries.
The Bottom Line
A variable life insurance policy might sound great to many. You have the option of picking a fixed policy with a set cash value amount and premium. Or you could choose a variable policy based on your investments. At the very least, you receive some type of death benefit.
But many others believe that you should not use this product as a primary form of life insurance coverage. This is due to the volatile nature of the underlying investments. More so than with other investments, it’s a good idea to carefully consider the risks before choosing a variable life policy.
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