Variable Life Insurance
Contents
What is variable life insurance?
Can I lose money in a variable life insurance policy?
How can I research a variable life insurance policy?
How does variable life insurance work?
What are some optional benefits of variable life insurance?
What will I pay for variable life insurance?
Should I exchange my variable life insurance policy for another?
What are the tax consequences of variable life insurance?
What is variable life insurance?
Variable life insurance is a contract between you and an insurance company and is a form of life insurance. Like other life insurance, it provides a death benefit to your family or other beneficiaries that may be significantly larger than the amount of premiums you pay.
Unlike other life insurance, variable life insurance has a cash value that varies depending, in part, on the performance of investments you choose from a menu of investment options—typically mutual funds. The insurance company usually reserves the right to make occasional changes to the available investment options.
In addition to providing a death benefit, variable life insurance may help you meet other long-term investment and tax planning objectives. Substantial fees, expenses, and tax implications generally make variable life insurance unsuitable as a short-term savings vehicle.
Different variable life insurance policies have different features. It is important to understand the policy you are considering, including fees and expenses, investment options, death benefits, and other features.
Can I lose money in a variable life insurance policy?
Yes. You can lose money in a variable life insurance policy, including potential loss of your initial investment.
Investment risk. The value of your investment and any returns will depend on the performance of the investment options you choose. If the investment options you selected for your policy perform poorly, you could lose money, including your initial investment. Each underlying fund may have its own unique risks. Review each fund’s prospectus before making an investment decision.
Insurance company risk. The financial strength of the insurance company that issues the policy backs all guarantees, including the death benefit. If the insurance company experiences financial distress, it may not be able to pay what it owes you under the policy.
How can I research a variable life insurance policy?
Ask your financial professional for the policy prospectus, which will describe the policy you’re considering in detail. Read the prospectus carefully and ask questions about what you don’t understand.
The underlying mutual fund options will also each have a prospectus. Review each fund’s prospectus before making an investment decision. Consider, for example, the fund’s investment objectives and policies, fees and expenses, risks, and whether it contributes to the diversification of your overall investment portfolio.
You can find variable life insurance and mutual fund prospectuses by searching the SEC’s EDGAR database.
If you are considering purchasing a variable life insurance policy through an investment professional such as a broker or an investment adviser, check them out using our Check Out Your Investment Professional tool. See if they are registered with us and if they have any disciplinary history.
How does variable life insurance work?
Premiums
With a variable life insurance policy, you will be required to pay premiums into an account. The amount of your premium payments that go into the account may be less than you paid because fees were taken out of the payments. The money in the account gets invested in a selection of investment options—typically mutual funds— that you can choose.
Some variable life insurance policies require you to pay a set amount in premiums. Others allow you to pay varying premiums as long as you contribute enough to cover policy fees and expenses.
If you do not maintain sufficient cash value to pay your policy’s fees and expenses, your policy may lapse. That means it will terminate without value and your beneficiary will not receive any death benefit. This might occur due to policy fees and expenses, poor investment performance or loans. A significant number of life insurance policies lapse. Some policies offer protection from lapse for an additional fee.
Free look period
You may cancel your policy within a short period (usually 10 to 30 days) of receiving it without a penalty fee called a surrender charge. This is called the free look period. Upon cancellation, you will typically receive a refund of your premiums. The refund may be adjusted up or down to reflect the performance of your investment options. Your contract should prominently state how long your free look period is and how to return your contract.
Death benefit
Variable life insurance pays a specified amount of money to your family or other beneficiaries when you die. This is called the death benefit.
When you purchase a variable life insurance policy, you select a face amount. This is the amount your death benefit is based on. For instance, a death benefit could be equal to:
the face amount;
the face amount plus the cash value of your account; or
the face amount plus the amount of premiums you contributed to your policy.
You may be able to purchase additional insurance features to increase the value of your death benefit. In addition, you may be able to increase your face amount at a later date. Such changes might require another medical examination or other evaluation by the insurance company.
Policy loans
Variable life insurance policies typically permit you to take loans on a portion of the policy’s cash value without incurring surrender charges or paying federal taxes. Policy loans typically have the following effects on your policy:
They reduce your policy’s cash value, which increases the likelihood your policy will lapse.
They may reduce your death benefit.
They are typically not subject to surrender charges.
You will typically owe interest on the amount borrowed.
They may be repaid without the deduction of a sales fee.
What are some optional benefits of variable life insurance?
Variable life insurance policies might offer other optional insurance benefits, for which you must pay extra. Optional features may also carry risks and limitations. Before deciding to pay extra for any of these features, carefully consider whether you need it and whether you can buy the benefit more cheaply separately (such as through a long-term care insurance policy).
Optional benefits for variable life insurance might include:
No-lapse features. A no-lapse benefit keeps your policy in effect even if you do not have sufficient account value to pay your policy’s fees and expenses. This feature may only be available in certain years, or if a certain level of premiums are paid. When elected, a no-lapse feature may significantly reduce your death benefit.
Disability rider. This benefit keeps your policy in force if you become disabled and cannot pay your policy charges.
Accelerated death benefit. This benefit pays a portion of your death benefit while you are still alive if you are chronically or terminally ill.
Long-term care insurance. This benefit provides coverage for the cost of long-term care.
Income benefit. This benefit provides a minimum level of monthly income to you or your beneficiaries for a specified period.
Additional term insurance. This benefit provides the opportunity to purchase additional term life insurance for you or your family as part of your variable life insurance policy. Term life insurance is a fixed amount of life insurance for a specified period.
Accidental death benefit. This benefit provides an additional death benefit if you should die because of an accident.
What will I pay for variable life insurance?
You will pay several ongoing and transaction-based fees and expenses when you invest in a variable life insurance policy. These fees and expenses may be significant and will reduce the value of your account. They may require you to pay additional premiums to prevent the policy from lapsing (terminating). The policy may quote fees and expenses on a monthly or yearly basis. Be sure you understand all the fees and expenses before you invest.
The more money you pay in premiums, the lower some of your policy’s fees and expenses may be. This is because your net amount of risk determines some policy fees and expenses. Your net amount of risk is the difference between your policy’s face amount and your policy’s cash value, so it goes down if there is more money in your account.
Certain charges are based on your personal characteristics. These charges may be more significant if you present a greater risk to the insurance company, that is, if you are more likely to die sooner.
Policy fees may go towards your financial professional’s compensation. They may receive higher compensation for selling some policies than for others.
Often, variable life insurance fees and expenses include the following:
Mortality and expense (M&E) risk fees. These ongoing fees are equal to a certain percentage of your account value. They help cover the risks the insurance company assumes with respect to the policy. Risks might include that the policy owner may die sooner than expected, that administrative and sales costs are higher than expected, and that policy owner behavior does not match the insurance company’s expectations.
Sales fees imposed on premiums. Sales fees are a percentage of the amount paid. They reduce the amount of your premium payment applied to the policy. They typically compensate the insurance company for sales expenses.
Cost of insurance. This ongoing fee varies for each insured based on factors including the insured person’s age, gender, health, and death benefit amount. It compensates the insurance company for providing the death benefit.
Administration fees. These ongoing fees help cover the insurance company’s costs of issuing and administering the policy, and activities such as processing claims, maintaining records and communicating with you. They may be charged as a flat account maintenance fee or as a percentage of your account value.
Transaction fees. These fees cover services you request. Some policies assess fees for transactions like transferring money among investment options, partial withdrawals, increasing or decreasing the face amount, or providing additional reports (such as policy illustrations).
Loan interest. If a policy permits you to take loans, you will be charged interest on any loan amount outstanding.
Underlying fund fees. When you buy a variable life insurance policy, your investment options are typically a range of mutual funds. You will indirectly pay the fees and expenses of the mutual funds you pick as your underlying investments. This is because mutual funds charge fees and expenses to their investors. These fees are in addition to the fees charged by the insurance company and are deducted from the returns of the investment options.
Surrender charge. This fee applies if you surrender the policy or make a withdrawal in the early years of the contract. It compensates the insurance company for sales expenses that it would otherwise not recover in the event of early surrender. Be sure to check the length of your surrender charge period when evaluating a policy.
Optional benefit fees. The optional features offered by some variable life insurance policies carry additional fees. These fees can vary significantly based on type of benefit and/or the individual insured.
Other fees may also apply.
Ask your financial professional to explain all charges that may apply. You can also find fees and expenses in the prospectus of a variable life insurance policy.
Should I exchange my variable life insurance policy for another?
In some cases you may wish to exchange an existing variable life insurance policy for a new policy that has features you prefer. If you are considering replacing your life insurance policy with another, here are some things to consider:
Cost of insurance. As you age, the cost to insure you is likely to increase, so a new policy may be more expensive. Be sure to compare the costs associated with an existing policy to any new policy.
Surrender charges. Surrender charges are typically higher in the early years you own a policy. If you exchange a policy, you may be subject to a surrender charge on your existing policy and a new surrender charge period on the new policy.
Compare policies. Be sure to compare the old and new policy features to determine which policy better suits your needs. Request a policy illustration from your financial professional comparing your old and new policy.
Tax consequences. Consider the tax consequences associated with any policy exchange.
Continuous coverage. Do not cancel your existing policy until your new policy is in effect to ensure that there is no gap in your insurance coverage.
Conflicts of interest. Consider the financial motivation your financial professional may have to recommend that you exchange one policy for another.
What are the tax consequences of variable life insurance?
Your cash value may accumulate on a tax-deferred basis. This means you will only be subject to federal income tax when you withdraw money from your policy. The policy’s gains will be subject to ordinary federal income tax rates rather than lower capital gains rates.
The death benefit paid to your beneficiaries is not subject to federal income tax. Under certain circumstances, the death benefit may not be subject to federal estate tax.
You may take loans from your policy without paying federal income taxes. However, if your policy terminates with a loan outstanding, you may owe federal income taxes on the loan.
The federal tax rules that apply to variable life insurance can be complicated and may change over time. In addition, there may be state tax implications. Before investing, you may want to consult a tax adviser about the tax consequences of investing in variable life insurance.
Additional Information
Using EDGAR to Research Investments
Characteristics of Mutual Funds and Exchange-Traded Funds (ETFs) – Investor Bulletin
Updated Investor Bulletin: How Fees and Expenses Affect Your Investment Portfolio
National Association of Insurance Commissioners (NAIC) — Variable life insurance is regulated by state insurance commissions, as well as by the SEC. You can find your state insurance commissioner through NAIC’s website here. You may contact your state insurance commissioner with questions or complaints about variable life insurance.
