By Joel Dansby* on Jul 11, 2020
Variable life insurance was introduced in the 1970’s as a way for people to achieve higher returns on the cash value portion of their life insurance policies. Because the cash value is actually invested in separate, managed accounts consisting of stock and bond portfolios, the potential is there to earn rates of return commensurate with the performance of the markets. When the stock market took off in the 1980’s few people could complain that their variable life policy didn’t live up to its potential.
Even as the markets declined, variable life policyholders were secure in the knowledge that their beneficiaries would receive no less than the minimum guaranteed death benefit. Variable life policies were even being promoted as “a way to invest in the market without losing your life”. It truly was a revolutionary way to purchase long term protection.
Variable life insurance today still holds the same potential for upside growth, and it still provides permanent, guaranteed protection. For people who are seeking long term, permanent life insurance protection it holds the same promise of protecting your beneficiaries against market risk while allowing you to manage your investments for greater returns. Even with their higher costs, a variable life policy has the potential, over time, to be the most cost effective way to own permanent life insurance coverage.
The issue that confronts a person today who is considering a variable life policy for long term protection and investment potential, is determining when is the best time to get one. Variable life is not for everyone, but for the person who can see the potential through the risks and costs associated with them, the time to get one is when you are properly positioned financially.
The ideal profile of a person who is ready to get a variable life policy is one who recognizes the need for long term protection, understands how investments work, has a long time horizon and can afford higher, fixed premium payments. Only after thoroughly reviewing one’s personal financial situation can a person determine if the time is right to get a variable life policy.
Long Term Protection Need
The advantage of a permanent life insurance policy such as variable life is that, as long as the premiums are paid on time, the coverage will continue. For the person who recognizes that the need for life insurance may not go away – to provide security for a spouse, to protect a business, to offset estate settlement costs, to leave a legacy – a variable life policy offers the potential to own that protection in the most cost effective way.
The best time to purchase this kind of long term protection is at an age when your mortality expenses are relatively low, some time in your 30’s or 40’s. People in their 50’s and 60’s who have a need for business protection or estate protection may also benefit from a variable life policy but they would have to weigh the higher cost of insurance against the potential for decent market performance.
A person with strong investment acumen understands the potential and the risks associated with managed accounts. They understand that markets fluctuate, but that, historically over time, they tend to go up. If you have experience investing in mutual funds and understand the principle of diversification, asset allocation and dollar cost averaging, you will be right at home with the managed accounts of variable life policies. There are some restrictions as to how often you can move your funds between accounts, however, there are no tax consequences for doing so.
Long Term Horizon
Variable life policies are recommended for younger people with the time to allow their cash value gains to catch up with and, eventually outpace the costs. There are costs associated with owning a life insurance policy that allows you to control your investments, pay no current taxes on your earnings, and have the life insurer guarantee that your beneficiaries will receive the original death benefit. These costs for investment management fees, mortality costs, and administrative fees, can add up, and, over time they can impede the growth of your cash value if the market performance is poor.
Investors with at least a 20 year time horizon have, historically done well in the financial markets with returns that have outperformed most alternative investments. The strategy of dollar cost averaging further enhances the potential for overall growth as fixed dollars can buy more shares in down market that improve the overall performance of the investment in up markets.
Fixed Premium Commitment
Premiums on variable life insurance are, generally, higher than other types of policies, in part because of these higher costs, and also because the life insurer levels out the premium so that you pay no more in the later years of your policy than you do in the very first year. In the early stage of the policy, when your mortality costs are lower, more of your premium goes to work in the managed accounts which give your money the chance to accumulate faster.
When the managed accounts perform well, and excess cash value accumulates, it can have the effect of increasing the death benefit and, it can potentially eliminate the need for additional premium payments. With sufficient cash value, the policyholder can simply use cash value accumulation to pay the premium, however, a policyholder should be prepared to pay the fixed premiums continuously.
A person who invests in a variable life policy realizes that a portion of their premium is relative to what they would pay for any life insurance policy and that the other portion is allocated towards the potential for achieving cash value gains that could be used to increase the death benefit, pay the premium, or even to access via a loan from the policy for some future need.
The Final Analysis
In the final analysis, the best time to get a variable life insurance policy is when you recognize the need for long term life insurance protection and you have weighed the market risk against the long term potential to achieve maximum benefits in the form of tax advantaged accumulation and a guaranteed tax free death benefit. Your cash flow situation and your time horizon should be such that they allow you to comfortably participate in the long term ride of your variable life policy.
Variable Life is considered an investment product and therefore represents a securities contract regulated by FINRA and must be sold with a prospectus.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2023 Advisor Websites.