Pros And Cons Of Variable Life Insurance

When the time comes to purchase life insurance, there are several factors to consider before committing to one policy (how much, which type of life insurance, etc).  Life insurance is often a necessary expense in order to protect our loved ones from financial disaster after we are gone.  Whether you are looking to replace income in the event of your death or cover funeral expenses, deciding which life insurance policy is right for you is a major decision. Today we will look specifically at variable life insurance to determine the positive and negative consequences of owning this type of policy.

What Is Variable Life Insurance?

Variable life insurance is a type of permanent or whole life insurance.  In other words when you purchase a variable life insurance policy you have permanent coverage up until the time of your death.  The term variable comes into play due to the nature of the investment portion of your policy.  You are allowed to allocate a percentage of your premium to a separate account which may include a money market fund, equity fund, bond fund or a combination.  Depending on the performance of the investment part of your policy, the death benefit and cash value may fluctuate.

Pros And Cons Of Variable Life Insurance

As with all forms of life insurance there are specific benefits and risks associated with variable life insurance.

Pros

This type of insurance allows the policy holder to invest the cash value of the policy in various financial vehicles.  Any capital gains or earned interest can be used toward policy premiums and are tax deferred.  Additionally, you can borrow against the cash value of your life insurance policy in a pinch (although it should be as a last resort).

Cons

Most variable life insurance policies provide a guaranteed minimum death benefit, however their is rarely a minimum guarantee on cash value.  This means you assume all risks associated with the investments.  If your investments perform poorly, you risk reducing the amount of cash value and death benefits your beneficiaries would receive in the event of your death.  Worse, the investment component of most variable life insurance policies is extremely expensive, often costing  15 times that of a low-cost index fund from one of the major mutual fund companies.  Since investment costs are so important, it is likely a low-cost, diversified portfolio in a taxable account would come out significantly ahead of the cash value of a variable life policy, even after taxes are taken into account.

Variable Vs Term Life Insurance

There are many debates over which type of insurance is better:  variable or term?  In probably 99% of the cases, term life insurance is the better deal.  The extremely high costs associated with most variable life policies in most cases completely eliminates the tax-deferral usually touted by insurance salesmen.  Quite simply, you would almost always be better off buying the cheaper term policy and investing the difference.

The main “risk” of term life insurance is whether or not the policy will still be in effect at the time of your death.  Since most people only need life insurance during their working years to help keep their family afloat in case of their early demise, that risk is probably acceptable.  For a minority of people who genuinely need a guaranteed death benefit no matter how long they live, whole life might make sense.  Everybody else is better off with the cheaper term policy.