If you love to watch the market and pride yourself on being a clever investor, then variable life insurance products are truly made for you. These products allow for a portion of the premium to be allocated to the insurance company's investment fund, allowing you to achieve investment profits tax-free for your beneficiaries.
In this article, we'll provide a detailed breakdown of variable life insurance products.
Variable Life Insurance
In a variable life insurance policy, the bulk of your premium is invested in one or more separate investment accounts. You have the opportunity to select from a wide range of investment options (fixed-income investments, stocks, mutual funds, bonds, money market funds, etc.) What's more, the interest that your accounts earn increases your account's cash value. Your risk tolerance and investment objectives determine the amount of risk you wish to undertake. You can also switch from one investment to another, depending on your insurance company's policy. (To read more about risk, see Determining Risk And The Risk Pyramid and Achieving Optimal Asset Allocation.)
Normally, insurers have their own professional investment managers supervising your investments. Therefore, you need only be concerned with the overall asset performance of the investment you have chosen. In this way, the investment risk can be managed (although it cannot be eliminated).
The Risks Involved with Variable Life Insurance
This policy is quite risky because your cash value and death benefits can fluctuate in accordance with the performance of your investment portfolio. Therefore, if your underlying investments perform well, your death benefit and cash value may increase accordingly; if your investments perform worse than you expected, your death benefit and cash value may decrease.
A variable life insurance policy does offer a guaranteed death benefit, which will not fall below a minimum amount even if the invested assets devalue significantly. For this guaranteed death benefit, you'll need to pay extra premiums. The funding of the death benefit will be done by applying an assumed rate of interest, usually around 4%. If the fund performance exceeds or declines beyond this assumed rate of interest, the death benefit will go up or down accordingly.
Generally, a minimum cash value is never guaranteed, as poor investment performance can diminish your entire cash value. As a result, you have to bear the brunt of the risk of poor investment performance.
Just as with whole life policies, you can borrow against your cash value – provided a substantial cash value has been accrued – but the amount of the loan is restricted due to the volatility of the investment account.
Taxes and Variable Life Insurance
As with permanent life policies, the cash value of a variable life insurance policy grows on a tax-deferred basis. Many insurers offer premium payments from your accumulated cash value, which means a reduction in premium payment. However, if the investments perform poorly, less money will be accessible from your cash value, and you will have to pay more in order to keep the policy in force.
If you are a smart investor and intend to spend your retired life in comfort, a variable life policy may be a perfect fit for you. Your exceptional investing skills and decisive power directly affect your policy's fund performance. Successful investments can double up your cash value, outstripping the value of a typical whole life policy. But keep in mind that failed investments can eat up a large chunk of your cash value, and cut down your chances of having a supplementary income. If you can bear this risk and are interested in tax-deferred earnings, then variable life is definitely worth looking into.
The Governing Bodies
Because this policy deals with security investment risks, it is considered a securities contract and is governed by prevailing securities law. It is obligatory to read the prospectus carefully before investing in a variable life insurance policy. Normally, the prospectus discloses the investment objectives, risk, charges, and expenses of the investment. Make sure that the agent selling you your variable life policy has a valid state license to sell life insurance, as well as an NASD license. (To find out more about the prospectus, see Don't Forget To Read The Prospectus!)
Variable Universal Life (VUL) Insurance
Variable Universal Life (VUL) insurance, as the name suggests, is a policy that combines variable and universal life insurance (i.e. flexible variable life insurance). This is one of the more popular insurance policies because it gives its policyholders the option to invest as well as alter the insurance coverage with ease. (Confused about universal life insurance? Read What is the difference between term and universal life insurance?)
As with universal life insurance, you have the ability to decide the amount and the frequency of premium payment, although within specific limits. You may also make a lump sum payment within certain limits, or use your accrued cash value toward premium payments.
The Risks Involved with Variable Universal Life Insurance
These policies allow you to increase and decrease you death benefit according to your wishes. An increase in the death benefit calls for evidence that you are enjoying good health, while a decrease in the death benefit may have surrender charges.
Unlike universal life insurance, this policy gives you the freedom to invest in your preferred investment portfolio. You may be a conservative or an aggressive investor, and your investment will reflect your risk tolerance. The investment options vary among insurers, but almost all VUL policies consist of investment in stocks, bonds, money market securities, mutual funds, and even the most conservative option of guaranteed fixed interest. Your cash value and death benefit will vary according to the investment performance.
As you know, there is a possibility that the underlying assets in your account may provide positive or negative returns. This affects your cash value, and thus insurers do not offer guaranteed cash value. Despite this, the flexibility in death benefits, premiums, and the potential growth in cash value make this policy attractive to some.
VUL provides insurance protection and the element of long-term investment. However, you should have a fundamental understanding of stocks, bonds, and securities before you invest. If you are considering buying VUL insurance, you also need to be clear about your future goals, such as providing income to a spouse, taking care of high estate taxes, or having a comfortable retirement.
Taxes and Variable Universal Life
Because it is a permanent life policy, VUL provides tax-deferred cash value and loan withdrawals, within certain limits, against the cash value. Normally, policy loans are tax free, but you need to confirm this with your insurance advisor, as the tax implications may differ from one state to another.
Because you bear the investment risk in these policies, if your investments perform poorly, this may mean that you'll pay higher premiums to sustain the policy.
The Governing Bodies
Like variable insurance, due to their inherent securities risk, VUL policies must be sold with a prospectus, and are governed by securities laws. You must carefully read the prospectus before buying a VUL policy.
The Bottom Line
Your insurance coverage needs may change over time, and variable life insurance products do a good job of factoring in this alteration. Whatever your age, you should consider your individual circumstances and the standard of living you wish to maintain for your family. Variable life as well as VUL policies form a perfect hedge against inflation. For some, control over their investments through variable life gives them the desired edge, while others may prefer VUL for its high level of flexibility and the policyholder's open-mindedness toward market fluctuations. The key to helping you choose is to fully research these two insurance plans and decide on the one that best suits your requirements.
Finally, before going for a variable life or VUL policy, make sure that your insurance company enjoys high ratings from major rating services such as Standard & Poors, AM Best, or others.