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What is it?
Variable life is a form of permanent life insurance--providing both a death benefit and a tax-deferred investment account. You pay a fixed premium that is first applied to the cost of the policy, then to various fees and charges, and finally the balance is invested in investment portfolios called subaccounts, which range in risk level. You direct how your money is allocated among the subaccounts according to your risk tolerance (you may also occasionally move money from subaccount to subaccount). The cash values (i.e., the investment portion) of the policy and the death benefit are determined by the performance of the subaccounts in which your money is invested and are not guaranteed (although most policies offer a guaranteed minimum death benefit, i.e., the "specified face amount"). The policy's cash values and death benefit will rise if your investments do well, or fall if your investments do poorly.
Caution: Guarantees are subject to the claims-paying ability of the insurer.
Caution: Variable life insurance policies are offered by prospectus, which you can obtain from your financial professional or the insurance company. The prospectus contains detailed information about investment objectives, risks, charges, and expenses. You should read the prospectus and consider this information carefully before purchasing a variable life or variable universal life insurance policy.
When can it be used?
You want permanent life insurance and control over investment options
If you want lifetime insurance protection (with term insurance, you must renew and perhaps retake a medical exam) and the ability to actively manage your cash values among a wide array of subaccounts and risk/return potentials, variable life may be an effective tool for you.
You are willing to assume the risks
With variable life, you assume the risks associated with the investment portfolios as well as those associated with the policy.
There are no guaranteed minimum cash values--they are equal to the current market value of the subaccounts. Further, the death benefit is directly linked to the performance of the subaccounts. If the subaccounts perform poorly, the death benefit could be less than you anticipate (but not less than the specified face amount).
If your policy's cash surrender value (cash values less outstanding loans plus interest plus surrender charges) declines below a certain value, your policy and your life insurance protection may terminate.
Tip: Obtain a personalized illustration of the policy you're considering and be sure to read the prospectus for each investment option carefully. Pay attention to investment objectives, expenses and surrender charges, and other fees and charges.
You intend to keep the policy long term
The primary goal of a variable life policy is lifetime insurance protection. If you surrender the policy within the first 15 years, you will be subject to surrender charges that will erode any gain that is distributed from the policy.
Strengths
Provides benefits common to all cash value insurance
Like other permanent life insurance policies, a variable life policy contains the following features:
- Cash values grow tax deferred
- Cash values can be borrowed against (and some policies may allow partial withdrawals)
Caution: Policy loans are generally not subject to income tax. However, interest on loans is generally not deductible. Loans increase the chance of policy termination due to insufficient cash value. Loans outstanding at the time of your death will reduce the amount of death benefit proceeds (and can reduce the proceeds below the specified face amount).
Caution: Partial withdrawals may have income tax consequences. Partial withdrawals can limit death benefit increases.
Your premiums are fixed
An important feature of variable life is the fixed premium. Some policies allow premium payments to be made from policy cash values once the policy has been in force for a certain period of time.
Generally, if your policy's cash surrender value reduces to no value, the policy terminates. However, some policies allow you to make premium payments to keep the policy in force regardless of cash values.
You control your cash value investments
With a variable life policy, you can choose among the cash value investment options offered by the insurer. You're also given an opportunity to move your money between investment options.
Caution: There may be a limit on how many times you can move your money between portfolios in a given time period, and you may be charged a fee for transfers. Check your policy.
Tip: The insurance company is required to send you periodic reports of your investment portfolio's performance and its effect on your policy.
Greater potential for cash value growth
A variable life policy offers investment options with varying risk/return potentials. Due to the investment nature of the variable life policy, your cash values have greater potential to grow than with traditional life insurance. Of course, you also have the potential to lose all cash values as well as any death benefit increases above the specified face amount.
Caution: Guarantees are subject to the claims-paying ability of the insurer.
Potential to increase death benefit
The federal government has enacted laws governing the tax treatment of life insurance. For federal income tax purposes, a policy will be treated as life insurance only if it falls within a specific definition. Generally, this definition requires that for a policy to be categorized as life insurance for tax purposes, a certain amount of risk must exist for the insurer. A "corridor" must exist between the cash value and the death benefit. In other words, the death benefit can't be composed of cash value only; there must be an insurance element present. With a variable policy, increases in your cash value force an increase in the death benefit to maintain the corridor.
Caution: Policy loans can limit death benefit increases.
Tradeoffs
Cash values and death benefit above the specified face amount are not guaranteed
The insurance company does not guarantee the investment performance of the investment options--you assume all the investment risk. You could lose your entire investment.
Partial withdrawals of cash value typically not allowed
With some types of cash value life insurance, you're allowed to withdraw some of your cash value from the policy. Partial withdrawals are usually not allowed with variable life policies. The only way to access your cash value is with a policy loan or total policy surrender. (However, some newer variable life policies may allow limited partial withdrawals.)
Tip: If you want to control your cash value investments and be able to make partial withdrawals from your cash values, a variable universal life insurance policy may be more appropriate for you.
Policy loans affect cash value
When you take loans against your policy's cash value, these amounts are not available to participate in the investment experience and no growth from them can result during the time the loans remain outstanding.
In addition, because your policy will terminate if its cash surrender value falls below a certain amount, loans increase the risk that your policy will terminate for insufficient cash value.
Policy loans affect death benefit
Your policy's death benefit can exceed the specified face amount if your investments experience favorable returns. However, when there are outstanding policy loans, these amounts can't grow, which in turn reduces the potential of the death benefit to grow.
In addition, if you die with an outstanding policy loan, the insurance company receives the loan repayment from the death benefit first. After the loan is repaid, the balance of the death benefit is paid to the policy beneficiary.
Policy fees and expenses reduce returns
You will be charged a variety of fee and expenses (reducing any gains you might experience) that may include:
- Sales charge
- Surrender charge
- Transfer fees
- Underwriting charge
- Administration charges
- Mortality and expense risk charges
- Loan interest
- Charges for optional features
Tax considerations
Income Tax
Policy loan proceeds generally not taxable
Generally, when you take out a loan against your variable life policy, the amount you receive is not considered taxable income.
However, if you pay more than a certain amount of premiums, you may cause your variable life policy to become a modified endowment contract. If it does, you will pay incomes taxes on loans to the extent that cash values are in excess premiums paid. A penalty tax may also apply.
In addition, if you surrender your policy or your policy lapses while there is an outstanding loan, the loan will be treated as a distribution (i.e., you'll pay incomes taxes on the loan to the extent that cash values are in excess premiums paid).
Policy loan interest not deductible
Interest payments on loans are generally not deductible for income tax purposes.
Policy cash value gains are taxable
You are not taxed on policy cash values until they are withdrawn. Generally, withdrawals that are less than or equal to premiums paid will not trigger income tax consequences.
If you surrender your policy or your policy lapses, distributions may be subject to income taxes if there is a gain in your policy.
Death benefits generally not subject to federal income tax
Policy death benefits are generally not subject to federal income tax. One notable exception is when the policy has been sold or otherwise transferred for valuable consideration by one policy owner to another, subjecting it to the transfer-for-value rule.
Gift TaxPolicy proceeds not considered gift to beneficiary
Proceeds paid to a beneficiary are not treated as a gift for gift tax purposes.
Policy premiums generally not subject to gift tax
Premium payments you make on your policy are not gifts to the beneficiary. However, premium payments made by someone other than the owner are taxable gifts to the owner if they exceed the annual gift tax exclusion amount of $13,000 per donee in 2009 (up from $12,000 in 2008).
Estate TaxPolicy proceeds included in estate value in some cases
The proceeds of your policy will be included in the value of your estate for federal estate tax purposes if you hold any incidents of ownership at any time during the three years before your death or if the proceeds are payable to yourself or your estate or executor. Incidents of ownership include (among other things) the right to change the beneficiary, take out policy loans, or surrender the policy for cash.
Policy proceeds often exempt from state death taxes
In many states, life insurance proceeds are exempt from state death taxes.
Copyright 2006-2011 Forefield Inc. All rights reserved.
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