What Is a Variable Death Benefit?
Let me explain what a variable death benefit is. It's the amount paid to a decedent's beneficiary based on the performance of an investment account within a variable universal life insurance policy, which acts as both insurance and an investment. You get this variable amount on top of a guaranteed death benefit, which stays constant.
As a policyholder, you can choose from several investment options your insurer offers, such as equity and fixed-income mutual funds. The variable part, or the policy's cash value, plus the guaranteed death benefit—known as its face value—make up the total death benefit.
Understanding Variable Death Benefit
You should know that a variable death benefit is one of three main options in variable universal life insurance policies, along with a level death benefit and a return of premium benefit. None of these are taxable to the beneficiary, and if you borrow against the policy, the death benefit decreases.
It's sometimes called an increasing benefit, but that's not entirely accurate because the cash value can go up or down based on investment performance.
Key Takeaways
- A variable death benefit is the amount in an investment account paid to a decedent's beneficiary from a variable life insurance policy.
- The investment account or cash value account within a variable life insurance policy is used to invest in stocks or equity mutual funds for returns.
- While investment accounts hold the promise of greater-than-average returns, their returns are not always positive and depend on the state of equity markets.
- Variable life insurance policies have associated management fees that may eat into the overall amount for the variable death benefit.
Pros and Cons of Variable Death Benefit
Typically, you're offered a set of securities and funds from the life insurance company, ranging from stocks to bonds to money market funds, each with management and administrative fees. Part of your premium goes to cash value accounts invested in these.
For variable universal life policies, a variable death benefit investing mainly in stocks or equity mutual funds might appeal to you if you're a younger investor using insurance as a long-term investment. If you're older, bonds could be more suitable.
Most variable death benefits let you change the underlying investments over time. Returns aren't capped, so you get the full return minus fees.
A variable death benefit can cost less over time than a return of premium benefit and offers tax benefits, with gains deferred until the death benefit is claimed.
However, it's usually more expensive than a level death benefit and has more embedded costs. Higher death benefits mean higher premiums, and there's a risk your policy lapses if you don't keep enough funds for administrative costs.
These cost differences matter, as total premiums for the three types can vary by thousands over the policy's life.
You might want to evaluate variable universal life overall. It doesn't expire if you keep paying, and premiums are flexible, but it's costlier than term insurance, which lacks investments and covers only a set period. You could buy term cheaper and invest the difference.
Example of Variable Benefit
Consider Shinzo, who has a variable life insurance policy with a $50,000 annual premium. He allocates $30,000 to an equity mutual fund and the rest to a bond fund. The next year, they return 5%, making his account $32,500. After a $2,000 administrative fee, his beneficiary gets a total death benefit of $30,500 at year's end.
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