Variable life insurance (VLI) is a specific type of permanent life insurance that offers a functionally hybridized spinoff insurance that provides lifelong coverage with investment potential. By utilizing some premium dollars to diversify cash value into investments, an owner of a VLI has the potential to grow the death benefit dollar for dollar while also being able to take advantage of market growth through accumulating into investment alternatives that include stocks, bonds, and mutual funds. This is a popular permanent life insurance choice for anyone who wants to help provide for their family’s post-death financial security while also potentially growing their wealth through thorough diversification. In this post, we’ll look at what VLI is, how VLI works, the positive and negative points, considerations you should have when deciding which type of policy is best for you, and things you can do to financially optimize your VLI to get the most out of your money.
What is Variable Life Insurance?
Variable life insurance (VLI) is a form of permanent life insurance where in addition to a death benefit paid to its policy owner’s beneficiaries, the policy owner receives the opportunity to direct part of their premium payment into various investment options. In turn, the death benefit and the cash value of the policy vary based on the performance of the underlying investments. Unlike whole life insurance where the cash value of the policy grows at a guaranteed interest rate, VLI provides the opportunity for higher returns through various investment options but is also subject to more risk.
How Does Variable Life Insurance Work?
The variable life insurance policy is made up of two components: the insurance portion and the investment portion:
Premium Payments:
Fixed Premiums: Policyholder makes level payments that go toward the cost of insurance (COI) and administrative costs, and the remaining amount goes into the investment options.
Importance: Regular premium payments are crucial to maintaining the policy's coverage and investment growth.
Investment Component:
Investment Options: Policyholders have the option to choose from various investment options including stocks, bonds, and mutual funds. If the investments perform well, the cash value and the death benefit of a policy will grow nicely, but if not, the policy may face turmoil.
Significance: The investment component is the one that has the potential to generate greater returns, but it also poses the risk of losing money if the investment does not perform well.
Cash Value Accumulation:
Growth Potential: The cash value emerges over time and can grow substantially based on the performance of the investments you select. The cash value can be borrowed and withdrawn — although it might reduce the death benefit.
Benefit: The cash value in a permanent life policy can be used by the policyholder while they are alive, setting it apart from a purely insurance instrument. A flexible financial planning tool.
Death Benefit:
Variable Death Benefit: The death benefit amount provided by this VLI policy is not set in concrete. It will either go up if the underlying investments perform well or down if they perform poorly. However, there is always some form of guarantee that the death benefit will be at least a certain minimum amount.
Significance: The death benefit depends on investment performance, and the careful monitoring of one’s investments is key to successful participation.
Benefits of Variable Life Insurance
Variable life insurance has many of the same advantages as traditional life insurance, with the added benefit that it has a cash value component, therefore also being an appealing investment opportunity for those with a high-risk tolerance and with long-term financial goals:
Investment Growth Potential:
High returns: Investing in a broad array of assets enables the potential for higher returns than available through traditional life insurance products.
Significance: Its potential for growth makes it an interesting investment for those comfortable with risk in the market and want to get rich slowly.
Lifelong Coverage:
Permanent protection: coverage lasts for your whole life Whatever you cough up as long as you pay the policy’s required premiums, your beneficiaries are getting a death benefit come hail or high water, regardless of when you die.
Advantages: It means life will always be insured, you don’t have to worry about your family or your insurers.
Tax Advantages:
Tax-Deferred Growth: The cash value in a VLI grows tax-deferred – you don’t pay taxes on any investment gains until you take them out.
Tax-Free Death Benefit: Beneficiaries typically receive the full amount of a death benefit without being taxed.
Benefit: These tax breaks increase the cash benefits of VLI, making it a good vehicle for passing your wealth on to your heirs.
Flexibility in Financial Planning:
Borrowing and withdrawing: the cash value of the VLI policy can be borrowed against or withdrawn. This reduces the death benefit but allows the policy to provide liquidity and financial flexibility.
Benefit: This flexibility can allow you to fund large costs – such as a child’s education or your eventual retirement – without liquidating other investments.
Risks and Considerations of Variable Life Insurance
Although it offers several advantages, there are also potential risks and considerations associated with variable life insurance, and its potential policyholders should keep that in mind.
Market Risk:
Investment Performance: The cash value and death benefit of the VLI policy are tied to and governed by the investment performance of the selected investments. Poor market performance can cause a reduction in both.
Imperative: Market risk should be embraced in the mind before VLI: it is a product that requires more active management and greater risk appetite from the person undertaking it.
Higher Fees and Costs:
Cost and Fees: Along with costly reviews, VLI policies generally come with a higher cost of investing compared with other types of life insurance, with management fees for the investment component and administrative charges deducted from the returns.
Takeaways: Know the total price of VLI. Many policies don’t include all ancillary costs in their premiums, meaning you’ll have to account for these when calculating the true value of the policy.
Complexity:
Investment decisions: Having a VLI policy involves having to make some or all of your own investment decisions (including learning the lingo). It is a time-consuming and difficult process; you will need to monitor your investments regularly and make changes accordingly.
Takeaway: Given the complexity of VLI, it’s helpful for a conscientious financial advisor or insurance professional to guide you through these steps.
Potential for Loss:
Volatility in cash value: sometimes the cash value goes down if the underlying investments underperform and then reduces the death benefit, or even lapses the policy if the capacity to generate cash value is not sufficient to cover costs.
Significance: The policyholder, especially a farmer, must prepare for a possible loss of crops or livestock when buying insurance, and have a plan to handle the associated risk.
Long-Term Commitment:
Policy Maintenance: VLI is a long-term financial obligation that requires regular premium payments, and the management of those investments. Lapsing or otherwise not maintaining the policy can result in a loss of insurance.
A caveat: do some homework and be sure your financial future is secure (you can pay the premiums for the duration of the policy) before you settle on VLI.
Conclusion
Variable life insurance can be a great investment because it represents a marriage between lifelong protection and growth opportunities, and it can offer life insurance growth with tax benefits. But VLI is a risky business, and it’s not appropriate for everyone who invests. If you have a higher tolerance for risk or you don’t like taking chances with important financial matters, VLI might not be for you. If, however, you have some affinity for or comfort with market investing and see VLI as a way to further your goal of creating wealth and providing for your loved ones, up to and including your children, a strong case can be made. But, by all means, seek the guidance of a financial specialist before taking the plunge. VLI might be for you, for your family, and for your future.
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