What it means
Every premium you pay is split three ways. Part covers the cost of insurance, part covers administration and sales charges, and the remainder goes into sub-accounts you choose from a menu the insurer provides.
The cash value belongs to you and grows without annual tax on gains, which is the feature that attracts higher earners who have exhausted other tax-advantaged options. You can normally borrow against it, and the death benefit passes to beneficiaries free of income tax.
The risk is that poor investment returns erode the cash value while the cost of insurance keeps rising with age. If the cash value runs out the policy lapses, and a lapsed policy after decades of premiums leaves you with nothing and possibly a tax bill on any outstanding loan.
Variable universal life is the common cousin, adding flexible premiums on top of the investment choice. Plain variable life keeps premiums fixed, which gives less flexibility but also less risk of underfunding the policy by accident.
Charges are the deciding factor in whether the product works. Total costs frequently run well above what an equivalent term policy plus a separate investment account would cost, so the case for it depends on genuinely needing permanent cover.
In practice
Real-world examples.
Example
A business owner aged 45 with a $4,000,000 estate buys a variable life policy inside a trust so the death benefit can cover the expected inheritance tax bill. She funds it heavily in the early years so the cash value builds a cushion before the cost of insurance climbs.
Example
A partner in an architecture practice uses a variable life policy to fund a buy-sell agreement. If either partner dies, the death benefit gives the survivor the cash to buy the deceased partner's share from the family rather than accepting a new co-owner.
Example
A couple in their thirties compare a variable life policy at $700 a month with a 30-year term policy at $85 a month. They choose term cover and invest the $615 difference in a low-cost index fund, since their need for cover ends once the mortgage is repaid.
Think of it
“Variable life has investment component-cash value depends on market performance.
Formula
Calculation
Cash value moves according to:
Ending cash value = (Beginning cash value + Premium paid - Insurance and administration charges) x (1 + Sub-account return)
A policyholder has a beginning cash value of $30,000 and pays an annual premium of $6,000. The insurer deducts $1,500 for the cost of insurance and administration, and the sub-accounts return 6% over the year.
Amount added to sub-accounts = $6,000 - $1,500 = $4,500
Balance before growth = $30,000 + $4,500 = $34,500
Ending cash value = $34,500 x 1.06 = $36,570
If instead the sub-accounts had fallen 10%, the ending cash value would be $34,500 x 0.90 = $31,050, meaning the year's $6,000 premium produced only $1,050 of cash value growth.Case study
Seen in the real world.
This is a fictional, illustrative story. Redhaven Joinery, an invented family cabinet-making firm, insured its managing director with a variable life policy carrying a $2,000,000 death benefit and an annual premium of $24,000.
For the first eight years the sub-accounts performed well and the cash value reached $148,000, which the family treated as a reserve. A sharp market fall then cut the cash value to $96,000 in a single year while the annual cost of insurance rose to $19,000 as the director turned 60.
The firm's accountant modelled the policy forward and found that at the reduced cash value it would lapse in eleven years unless premiums increased. Redhaven chose to raise the annual payment to $31,000 and switch part of the sub-account mix into bonds, illustrating that a variable policy needs active monitoring rather than being filed away.
Watch out
Common mistakes.
- Thinking the death benefit is guaranteed regardless of investment performance. In most contracts the base benefit only holds while the cash value can cover the deducted charges, so a badly performing policy can lapse.
- Buying it as an investment first and insurance second. If you do not need permanent cover, term insurance plus a separate investment account is almost always cheaper.
- Ignoring policy loans. Borrowing against the cash value reduces the death benefit and, if the policy later lapses with a loan outstanding, can trigger an unexpected income tax charge.
Questions
People also ask.
How does it differ from whole life insurance?
Whole life credits a rate set by the insurer and carries no market risk to the policyholder, while variable life passes sub-account performance directly through to the cash value.
Can I lose money in a variable life policy?
Yes, the cash value can fall with the markets, and charges continue to be deducted whether the sub-accounts rise or fall.
Is the cash value the same as the surrender value?
No, the surrender value is the cash value minus any surrender charges and outstanding loans, and in the early years it is often far lower.
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