How Variable Life Insurance Compares to Other Products
If you’re considering variable life insurance, it’s important to consider how this policy stacks up to similar financial products.
Variable Annuity vs Variable Life Insurance Policy
A variable annuity is just a tax-deferred annuity in which you get to choose how the value of the annuity is invested. It’s somewhat similar to a variable life insurance policy in that:
You can choose how the product’s value is invested. Both products typically have a wide range of options across equities, bonds and money market instruments. If you choose poorly, the value of your investment can decrease.
It comes with a death benefit. With variable annuities you assign a beneficiary and, if you pass away, your beneficiary would receive a specified amount of money. This is typically the remaining value of the annuity or the sum of your premiums minus any withdrawals. This is a bit different from a variable life insurance policy which has a lifelong death benefit. Investment gains are tax-deferred.
Withdrawals above your basis are subject to income tax. For variable annuities, this means you’ll be taxed on the growth of your investments. * For a variable life insurance policies, if you withdraw a greater amount of cash value than the total amount you’ve paid in premiums, you pay taxes on the difference. This also applies if you surrender the policy.
You would have to pay surrender charges to make a withdrawal during the first several years.
You can choose to pay in a lump sum or in smaller payments over time.
The primary difference between a variable annuity and variable life insurance is that with a variable annuity you receive your investment back in a series of payments from the insurer. With a variable life insurance policy, you can make a series of withdrawals from the policy’s cash value, make a single large withdrawal or simply use the cash value as collateral in a policy loan.
Variable annuities are also restricted in that you may have to pay a fee in order to make withdrawals before a certain age. Withdrawals from variable life insurance policies are only restricted by the amount of cash value available.
Variable Life Insurance vs Whole Life Insurance
Both variable and whole life insurance offer lifelong coverage, but whole life insurance policies are “lower risk, lower potential reward”. Whole life insurance policies have:
Level premiums - You pay a consistent amount in each premium payment.
Level death benefit - The death benefit is guaranteed and won’t fluctuate.
Guaranteed returns - Your cash value grows consistently and is typically guaranteed to equal the policy’s death benefit when the policy matures (usually when you turn 100).
In addition, whole life insurance policies have lower fees are they’re not regulated as securities. The downside is that whole life insurance policies have fixed upside potential. The cash value of variable life insurance policies can grow at a much faster rate and in certain cases can be used to pay premiums. Whole life insurance policies don’t offer the flexible premiums of variable universal life insurance policies.
Variable Life Insurance vs Mutual Funds and Term Life Insurance
“Buy term and invest the difference” is a phrase often used to discourage people from buying cash value life insurance policies, such as variable life insurance. If your financial obligations are likely to go away within 20 to 30 years, then purchasing term life insurance is likely to be a better option as it’s significantly less expensive than variable life insurance.
For example, if you are purchasing life insurance to make sure your family could stay in your home if you pass away and you have a 15 year mortgage, you would do better with term life insurance. Similarly, if you could save enough money over the next couple of decades to handle any future financial obligations, you should do so and just buy term coverage as a backup. With variable life insurance, you’re paying more to have a death benefit in place for the length of your life.
Now, there’s a separate question of whether you would want to buy cheaper permanent life insurance, such as guaranteed universal life insurance, and invest the difference in mutual funds or ETFs. There are pros and cons to both options but we would typically recommend maxing out contributions to retirement accounts prior to investing in variable life insurance. With a 401(k) or IRA, your money will grow tax-deferred and you’ll have a wider variety of investment options with lower fees. The only downside is that it will be harder to access your money for a period of time, but even variable life insurance policies have surrender and withdrawal fees.
Assuming your retirement accounts are fully funded, then whether to put your money in a brokerage account or variable life insurance policy is dependent on how you believe the investment options of the variable policy will perform. Tax-deferred growth can counteract moderate management fees if your cash value performs well enough, but you need to evaluate expected performance for yourself.