Variable Life Insurance: Understanding The Savings Portion Calculation

Variable life insurance is a permanent life insurance policy that combines lifelong insurance coverage with an investment element. The savings portion of variable life insurance policies depends on the performance of fixed-income investments and mutual funds chosen by the policyholder. Policyholders can direct their policy's cash value into various stock and bond accounts, and the cash value can grow significantly when the market performs well. However, market downturns can also decrease the cash value, making this type of policy suitable only for those comfortable with risk.

Mutual funds

Variable life insurance is a form of life insurance that combines a death benefit with an investment component. The death benefit is the amount of money that your beneficiaries will receive when you die. The investment component is a cash-value account, where the money is invested in assets like mutual funds. The value of the account will depend on the premiums you pay, how your investments perform, and the associated fees and expenses.

When investing in mutual funds through a variable life insurance policy, it's important to consider the fees involved. Mutual funds typically charge management fees, which are paid to the fund manager for their services. These fees can vary depending on the fund and may impact your overall returns. Additionally, there may be other fees associated with the variable life insurance policy itself, such as sales charges, mortality and expense risk fees, and administrative fees. It's crucial to understand all the fees involved before investing.

When choosing a mutual fund through a variable life insurance policy, it's also essential to consider your investment goals, risk tolerance, and time horizon. Different mutual funds have different investment objectives, ranging from conservative to aggressive. Some funds may focus on capital preservation, while others may seek higher returns by investing in riskier assets. Understanding your own risk tolerance and investment goals can help you select a mutual fund that aligns with your financial objectives.

Additionally, the time horizon, or how long you plan to invest, is an important consideration. Mutual funds that invest in riskier assets may be more suitable for long-term investment horizons, as they have more time to recover from potential losses. On the other hand, more conservative funds may be more appropriate for shorter-term investment goals.

In conclusion, mutual funds can be a valuable investment option within a variable life insurance policy, offering the potential for long-term growth and professional management. However, it's important to carefully research and understand the fees, investment objectives, and risks associated with the specific mutual funds available through the variable life insurance policy before making any investment decisions.

Fixed income investments

Fixed-income investments are a crucial aspect of financial planning, and life insurance policies, such as whole life insurance and universal life insurance, can serve as valuable tools in this area. These permanent life insurance policies enable individuals to build cash value over time, providing access to funds that can be utilised during their lifetime.

Whole life insurance, the most common type of permanent life insurance, offers a death benefit along with the ability to accumulate cash value. A portion of the monthly premium is allocated to a cash value account, which grows at a guaranteed minimum rate specified in the policy. The premiums on these policies typically remain consistent throughout the life of the policy.

Universal life insurance functions similarly to whole life insurance, allowing policyholders to grow an asset by accruing interest over time. However, unlike whole life insurance, universal life insurance premiums are not set and may fluctuate. Additionally, there are no guarantees on the rate of return. Under the universal life insurance umbrella, variable universal life insurance offers policyholders greater investment flexibility by enabling them to invest their earnings into accounts of their choosing, including mutual funds, thereby potentially earning higher returns over time.

When considering fixed-income investments, it is essential to evaluate the potential risks and returns associated with different options. Life insurance policies, such as whole life insurance, may provide competitive net returns on cash value accumulation compared to traditional bond investments. This is because the insurance company's general account can often earn higher returns than individual households due to better risk management and longer-term investment strategies. Additionally, the tax-deferred nature of life insurance policies can further enhance the attractiveness of these investments.

In conclusion, life insurance policies with a cash value component, such as whole life insurance and universal life insurance, can be valuable tools for fixed-income investments. These policies offer individuals the opportunity to build and access cash value while also providing the added benefit of a death benefit. However, it is important to carefully consider the associated fees, charges, and potential risks before making any investment decisions.

Policy fees

Sales Fees

Sales fees are typically imposed as a percentage of the premium amount. They compensate the insurance company for sales expenses incurred in selling the policy. Sales fees reduce the portion of the premium payment that is applied to the policy value.

Surrender Charges

A surrender charge is a fee incurred when the policyholder surrenders the policy or makes a withdrawal during the early years of the contract. This fee compensates the insurance company for sales expenses that would otherwise not be recovered if the policy were surrendered early. The length of the surrender charge period is an important consideration when evaluating a variable life insurance policy.

Mortality and Expense (M&E) Risk Fees

These are ongoing fees that are calculated as a percentage of the policyholder's account value. M&E risk fees help cover the risks assumed by the insurance company, including the possibility of the policyholder dying sooner than expected, higher administrative and sales costs, and policyholder behaviour that deviates from the company's expectations.

Cost of Insurance

The cost of insurance is an ongoing fee that varies for each insured individual, depending on factors such as age, gender, health status, and death benefit amount. This fee compensates the insurance company for providing the death benefit, which is a guaranteed minimum benefit for beneficiaries.

Administration Fees

Administration fees are ongoing charges that cover the costs of issuing and administering the policy. These fees may be charged as a flat account maintenance fee or as a percentage of the account value. They help cover expenses such as processing claims, maintaining records, and communicating with policyholders.

Loan Interest

If a variable life insurance policy permits loans, the policyholder will be charged interest on any outstanding loan amount. This interest accrues over time, similar to interest on a traditional loan.

Underlying Fund Expenses

In addition to the fees charged by the insurance company, there are also ongoing fees and expenses associated with the underlying investment options, typically mutual funds. These underlying fund expenses are reflected in the performance of the investment options and are indirectly paid by the policyholder.

Transaction Fees

Transaction fees are charged for specific services requested by the policyholder. These may include transactions such as transferring funds between investment options, partial withdrawals, increasing or decreasing the face amount of the policy, or requesting additional reports or policy illustrations.

Fees for Optional Features

Variable life insurance policies may offer additional optional features such as long-term care insurance, accidental death benefit, or disability riders. These features come with their own set of fees and expenses, which vary based on the type of feature and the individual insured.

It is important to carefully review the prospectus provided by the insurance company, as it contains detailed information about all applicable fees and expenses associated with the policy. Understanding these policy fees is crucial in making an informed decision about variable life insurance.

Investment risks

Variable life insurance policies are considered more volatile than standard life insurance policies. They carry more risk because the cash value component is typically invested in assets like mutual funds, meaning it may rise or fall in value. If the market takes a downturn, the cash value and added benefits may decrease, making this policy’s value subject to frequent changes.

Variable life insurance involves investment risks, just like mutual funds. If the investment options you select perform poorly, you could lose money, including your initial investment. The insurance company does not guarantee a rate of return and does not offer protection for investment losses. As with any investment, the cash value component of a variable life insurance policy comes with risk.

The value of your investment and any returns will depend on the performance of the investment options you choose. Each underlying fund may have its own unique risks. You should review the investment option’s prospectus before making an investment decision. You should consider a variety of factors with respect to each fund option, including the fund’s investment objectives and policies, management fees and other expenses that the fund charges, the risks and volatility of the fund, and whether the fund contributes to the diversification of your overall investment portfolio.

The financial strength of the insurance company is also important. All guarantees, including the death benefit, are backed by the financial strength of the insurance company that issues the policy. If the insurance company experiences financial distress, it may not be able to meet its obligations to you.

Tax implications

Variable life insurance policies have specific tax benefits, such as the tax-deferred accumulation of earnings. This means that 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 the lower capital gains rates.

Provided the policy remains in force, policyholders may access the cash value via a tax-free loan. However, if your policy terminates with a loan outstanding, you may owe federal income taxes on the loan. Also, interest or earnings included in partial and full surrenders of the policy are taxable at the time of distribution.

The death benefit paid to your beneficiaries is not subject to federal income tax. Under certain circumstances, the death benefit may also not be subject to federal estate tax.

Frequently asked questions