What Is a Variable Death Benefit?
A variable death benefit refers to the amount paid to a decedent’s beneficiary, influenced by the performance of an investment account within a variable universal life insurance policy. This financial product serves as both insurance and an investment. This variable amount complements a guaranteed death benefit, which remains constant.
Policyholders can choose from various investment options provided by their insurer, including equity and fixed-income mutual funds. The total death benefit comprises the policy’s cash value and the guaranteed death benefit, known as its face value.
Appreciating the Variable Death Benefit
Variable death benefits are amongst the primary types of death benefits in variable universal life insurance policies, alongside level death benefits and return of premium benefits. These benefits are not subject to taxation for the beneficiary, though borrowing against the policy decreases the death benefit.
Key Takeaways
- Investment-Driven: The beneficiary receives an amount influenced by the returns from an investment account within a variable life policy.
- Diverse Investment Options: Policy cash value can be invested in stocks or equity mutual funds for potentially higher returns.
- Market Dependent: Returns, and hence the death benefit, are contingent upon the equity markets’ performance.
- Management Fees: Policies include management fees, which may affect the variable death benefit’s overall amount.
Weighing the Pros and Cons
Investors select from various securities and funds provided by the life insurance company. These may include stocks, bonds, and money market funds, each accompanied by administrative and management fees. Variable life policies allocate a portion of the premium to invest in these equities.
For younger investors seeking a long-term investment vehicle, equities are often attractive. Older investors may prefer bonds. Policies typically allow changes to the underlying investments over time, offering full returns minus associated fees.
Advantages:
- Cost Efficiency: Potentially lower long-term cost than return-of-premium benefits.
- Tax Benefits: Gains on investments remain tax-deferred within the account until claimed as part of the death benefit.
Disadvantages:
- Higher Costs: Generally more expensive than level death benefits with additional embedded costs.
- Policy Lapse Risk: Insufficient funds may cause a lapse if administrative costs are not met.
- Higher Premium Differences: Different death benefits lead to substantial premium variations over policy duration.
Consumers must weigh the appealing features of variable universal life insurance—such as non-expiring coverage and flexible premiums—against its higher cost compared to term insurance. An alternative could be to buy a term policy at a lower cost and invest the difference separately.
A Real-World Example
Consider Shinzo, who invests in a variable life insurance policy with an annual premium of $50,000. He allocates $30,000 to an equity mutual fund and the rest to a bond fund. In the subsequent year, these investments yield a 5% return, bringing the account value to $32,500. After an annual administrative fee of $2,000, his beneficiary stands to receive a total death benefit of $30,500 at the year’s end.
Related Terms: cash value, guaranteed death benefit, level death benefit, return of premium benefit.
References
- Internal Revenue Service. “Life Insurance & Disability Insurance Proceeds”.
- U.S. Securities and Exchange Commission. “Investor Bulletin: Variable Life Insurance”.
