What Is Variable Life Insurance?

Variable life insurance is a permanent life insurance policy with an investment component. The policy has a cash-value account, which is invested in a number of sub-accounts available in the policy. A sub-account acts similar to a mutual fund, except it's only available within a variable life insurance policy. A typical variable life policy will have several sub-accounts to choose from, with some offering upwards of 50 different options.

The cash value account has the potential to grow as the underlying investments in the policy's sub-accounts grow. At the same time, as the underlying investments drop, so may the cash value.

Key Takeaways

  • Variable life insurance is an insurance policy in which the payout amounts are determined by the performance of the underlying securities in the policy.
  • Like the market, variable policies will return more when the market is up, and less if the market is down.
  • Variable life insurance policies are considered much more volatile than standard life insurance policies and are ideal only for those who can stomach the additional risk.
  • Due to it being a life insurance policy, when a variable policy is doing well, it can have significant tax advantages. Even when the policy isn't performing as expected, you won't be required to pay taxes on your distributions.

Understanding Variable Life Insurance

The appeal to variable life insurance lies in the investment element available in the policy and the favorable tax treatment of the policy's cash value growth. Annual growth of the cash value account is not taxable as ordinary income. Furthermore, these values can be accessed in later years and, when done properly through loans using the account as collateral, instead of direct withdrawals, they may be received free of any income taxation.

Similar to mutual funds and other types of investments, a variable life insurance policy must be presented with a prospectus detailing all policy charges, fees, and sub-account expenses.

Additionally, some of the best life insurance companies, including Prudential and New York Life, offer variable life insurance policies.

Advisor Insight

Steve Kobrin, LUTCF
The firm of Steven H. Kobrin, LUTCF, Fair Lawn, NJ

Under the right circumstances, variable life insurance can receive favorable tax treatment and offer the chance to make money in the market and not pay taxes.

First, you have to qualify for a low premium. If the cost of insuring you is too high, it will significantly impede your cash growth.

Second, this product is treated legally as a security and rightfully so. Like any investment, you have to manage risk and reward, factor in expenses, stay on top of asset allocation and do everything else needed to ensure optimum performance. If you are not prepared to do this yourself, make sure you have an advisor who will.

You also need to understand how to work within existing tax laws. There's a right and wrong way to grow cash inside life insurance and take it out. Mistakes can be very costly.