What Are the Elements of a Variable Life Policy?

A variable life insurance policy is a type of permanent life insurance offering both a death benefit and a cash value component. It provides coverage for the insured’s entire lifetime, unlike term life insurance which covers a specific period. A key feature of variable life insurance is that its cash value is tied to the performance of underlying investment options.

Beyond providing a death benefit, a variable life policy functions as a tool for cash accumulation, with its value growing based on investment performance. Policyholders pay premiums into an account; after deductions for fees, the remaining amount is invested in selected options. This structure offers a blend of insurance protection and investment opportunity.

The Death Benefit

The death benefit within a variable life policy is the amount paid to beneficiaries upon the insured’s passing. This payout serves to replace income, cover debts, or provide for future financial needs. The death benefit can fluctuate based on the performance of the underlying investments.

Policyholders have two common options for structuring the death benefit. A level death benefit maintains a consistent payout amount. With this choice, cash value growth typically increases the net death benefit to beneficiaries, as the insurance component decreases while cash value grows. This option generally results in lower premiums due to more predictable insurer liability.

An increasing death benefit pays the initial face amount plus the accumulated cash value. This means the death benefit can grow over time as the policy’s cash value increases. While offering a larger payout, this option typically involves higher premiums compared to a level death benefit. The cost of insurance is higher with an increasing death benefit because the insurer’s “net amount at risk” is greater.

Investment Sub-accounts

The cash value of variable life policies is invested in separate accounts, commonly referred to as “sub-accounts.” These sub-accounts function similarly to mutual funds, offering various investment choices such as stocks, bonds, and money market options. Policyholders select from these options, aligning choices with their risk tolerance and financial objectives.

The performance of these chosen sub-accounts directly influences the policy’s cash value; positive returns increase its value, while poor performance can lead to a decrease. This direct link means the policyholder bears the investment risk.

The cash value accumulates on a tax-deferred basis, meaning investment gains are not taxed as long as they remain within the policy. This feature allows for compounding of returns. However, the account value can vary significantly based on premiums paid, policy fees, and investment performance. Policyholders often have the flexibility to reallocate funds among sub-accounts, typically within certain limits and sometimes without transaction fees.

Policy Premiums

Premiums for a variable life policy maintain coverage and fund the investment component. While some variable life policies have fixed premiums, others, like variable universal life policies, offer payment flexibility. Policyholders can adjust premium payments based on financial circumstances and policy performance.

A portion of each premium covers policy expenses and the cost of insurance, which is the actual cost for the death benefit coverage. The remainder is directed into the policyholder’s chosen investment sub-accounts.

“Overfunding” involves paying more than the scheduled premium, accelerating cash value growth. This additional cash value can increase the death benefit or cover future premiums. Conversely, “underfunding” occurs when insufficient premiums are paid, depleting cash value and potentially leading to policy lapse if the cash value cannot cover ongoing fees and the cost of insurance.

Policy Fees and Charges

Variable life insurance policies involve various fees and charges that impact cash value growth and overall returns. One common charge is the mortality and expense (M&E) risk fee, which compensates the insurance company for the risk of paying out the death benefit sooner than expected and covers other guaranteed features. These fees are typically an annual percentage of the account value, often ranging from 0.40% to 1.75%.

Administrative fees are deducted to cover policy administration and record-keeping, either as a flat monthly fee or a percentage of the premium. Investment management fees are charged within the sub-accounts, similar to mutual fund expense ratios, to cover the costs of managing the underlying investments. These fees vary based on selected investment options and active management level.

The cost of insurance (COI) charge is a significant deduction, representing the actual cost of the death benefit coverage. This charge is based on factors such as the insured’s age, gender, health, and the death benefit amount, and typically increases with age. Surrender charges may apply if the policy is canceled or substantial withdrawals are made during the initial years, often within the first 7 to 15 years. These charges recoup the insurer’s upfront costs, such as sales commissions.

Accessing Policy Value

Policyholders can access the accumulated cash value in a variable life policy through several methods. A policy loan allows borrowing against the cash value, which serves as collateral. These loans typically accrue interest, and any outstanding balance, plus accrued interest, will reduce the death benefit if not repaid. Policy loans are generally not considered taxable income as long as the policy remains in force.

Withdrawals directly reduce the policy’s cash value and the death benefit. If the amount withdrawn exceeds total premiums paid, the excess may be subject to federal income taxation at ordinary income rates. Withdrawals may also incur surrender charges, especially if taken early in the policy’s life.

Policyholders can also surrender the policy for its cash surrender value. This value is the accumulated cash value minus any outstanding loans, interest, and applicable surrender charges. While surrendering provides access to the remaining cash value, it terminates insurance coverage and the death benefit. Any gains realized upon surrender, meaning the cash surrender value exceeding premiums paid, are subject to taxation.