Variable Life Insurance Vs Roth Ira: Which To Choose?

Variable life insurance is a type of permanent life insurance that combines a death benefit with an investment feature. It is often sold as a retirement account, but it is expensive and comes with more risk than a Roth IRA. Roth IRAs are usually the best vehicles to save for retirement. However, a permanent life insurance policy with a cash value component can be a good supplement for some high-net-worth individuals.

If you are considering cancelling your variable life insurance for a Roth IRA, you should take into account your income, tax-protected investment space, and the fees and risks associated with each option.

Variable life insurance has low gains

Variable life insurance policies are permanent life insurance policies that have a higher potential for earning cash compared to traditional policies. However, they often have higher fees and management costs than other kinds of permanent life insurance. These fees can eat into the investment gains made by the policyholder, resulting in low net gains.

Variable life insurance policies have a cash value component that can be invested in securities such as stocks, mutual funds, index funds, and bonds. The policyholder has control over how this money is invested, but there is a risk of losing money if, for example, a stock dips in price or the company goes bankrupt. The investments are also subject to market volatility, which can lead to losses during poor-performing years.

In addition to the risks associated with market performance, variable life insurance policies come with various fees and charges that can impact the overall returns. These include mortality and expense risk charges, sales and administrative fees, investment management fees, policy loan interest, and surrender charges. These fees can be quite high, especially for actively managed investments, and they may offset any potential earnings.

While variable life insurance policies offer the potential for higher returns compared to traditional policies, the fees and investment risks associated with them can result in low net gains for policyholders. Therefore, it is essential to carefully consider the costs and potential benefits before investing in variable life insurance.

Variable life insurance is a poor investment for retirement

Variable life insurance also has high costs, including insurance costs, which can be higher for the elderly, and surrender charges. These costs can reduce returns and flexibility. For example, if you decide you no longer want the policy, you may face a surrender charge and lose a significant portion of your cash balance. Variable life insurance also has a long-term commitment, which may not suit everyone.

There are better alternatives to variable life insurance for retirement. These include a 401(k), IRA, or Roth IRA, which offer tax advantages. Term life insurance is also a more affordable option for those who need a death benefit.

Variable life insurance is a complex product

Variable life insurance is a combination of insurance and investments. The odds of the company offering the best of both are slim. Variable life insurance is also generally sold with large commissions, which are a conflict of interest and never come back to the buyer.

Variable life insurance can be beneficial for high-net-worth individuals who have already maxed out their contributions to traditional retirement accounts and have income to spare. However, there are a lot of variables and assumptions that need to be considered when deciding if variable life insurance is right for you.

Variable life insurance is expensive

High Commissions

Variable life insurance is sold by commissioned salespeople. These commissions are often very high, sometimes as much as 40-80% of the first year's premium. This is a conflict of interest, as the salesperson has a strong incentive to recommend the product which pays the highest commission, which is often the worst product for the customer.

Complexity

Variable life insurance is a complex product with a lot of moving parts and assumptions. The prospectuses and disclosures for these products are often hundreds of pages long. This complexity makes it difficult for customers to understand what they are buying, and makes it easier for salespeople to sell products which are not in the customer's best interests.

Mixing Insurance and Investing

Variable life insurance combines insurance and investing. This means that customers end up with inferior insurance and investments. It is unlikely that the company has combined the best possible insurance with the best possible investments.

Surrender Charges

Variable life insurance policies often have surrender charges, which means that if you cancel the policy within the first few years, you will lose not only your death benefit but also a considerable portion of your cash balance.

High Investment Fees

Variable life insurance policies often have high investment fees, typically around 3% per year. By contrast, the average expense ratio for open-end mutual funds and ETFs is between 0.5% and 1.0%.

Poor Investment Options

Variable life insurance policies often have poor investment options, such as actively managed funds with high expense ratios. Even if a variable life insurance policy has good investment options, there is no guarantee that the insurance company will not substitute them for terrible loaded high-expense-ratio funds in the future.

Lack of Flexibility

Variable life insurance policies require long-term commitments, often of several decades. This means that customers are locked in to making large premium payments for many years, even if their financial situation changes.

Risk of Regulatory Change

Variable life insurance policies are subject to regulatory change, which could make them less advantageous in the future. For example, the US government could change the tax rules around these policies, or the insurance company could change the rules around the policy.

Variable life insurance is not flexible

Variable life insurance policies are complex and require more hands-on attention. They typically have higher premiums than other cash-value life insurance policies. The fees tend to be the highest of any permanent life insurance policy, including mortality and expense risk charges, sales and administrative fees, and investment management fees.

Variable life insurance policies also have a surrender period, during which you will pay fees if you withdraw part of the cash value or cancel your coverage. This can be costly, especially in the first 10 to 15 years of the policy when the cash value is typically not equal to the actual surrender value.

In addition, if you use the cash value of the policy as collateral for a loan, the insurer will charge interest on the loan. This loan interest, along with the other fees associated with variable life insurance, makes it a costly option.

Variable life insurance may be a good choice for individuals who are comfortable with risk and want the potential for higher returns. However, it is important to carefully consider the fees and charges associated with these policies, as they can add up quickly and eat into any potential gains.

Frequently asked questions