A variable death benefit may be awarded to your beneficiaries under two circumstances. You may purchase something called variable annuity life insurance, which allows you to designate that your invested money be shifted into different investments. If you die before the annuity has reached full value, there’s usually a stock payment of life insurance that can go to beneficiaries.
Variable annuity life insurance is often criticized. It has numerous fees, and if you borrow money against it, you have to maintain the account for your lifetime, or any money borrowed is automatically considered taxable income. This can be a heavy blow if you’ve invested a lot in the policy (and you do get to choose how much you invest each month). It’s similar to having a mutual funds account and a life insurance policy at the same time. As for death benefits, the variable death benefit under this type of life insurance usually has a guaranteed minimum payout, but can be considerably higher if your investments perform well and you don’t remove money from the account.
Another type of variable death benefit that may be available as a form of life insurance is when an insurance company invests your premiums, along with other people’s premiums, into different investments like mutual funds. You aren’t making the choices as to where you will invest — this is up to the company. As a result, the death benefit may rise or fall depending how well these investments prosper. Most companies still offer a minimum amount for beneficiaries. If you maintain such a policy for life, this minimum amount may be less than your total amount paid, or it may be much more if an insurance company’s investments have prospered.
Most often, the term variable death benefit is used in connection with variable annuity life insurance. Frequently, investment experts advise against this insurance because of a variety of hidden fees, and for anyone who might plan to borrow against this type of insurance. These fees can include sales commissions and management of your investment, which may amount to about 2% a year, and an annual fee that helps pay for the insurance portion and death benefits, which can be up to 1% of your investments. If your investments aren’t performing well or are barely performing, any money you make may be lost in fees.
Many people are sold on the variable annuity life insurance because they see the possibility of leaving their heirs a much bigger payout, and because they’re promised tax-free ways to borrow against this money in the future. It’s important to note that this money only remains tax-free as long as the account remains open. If you allow the account to lapse, or max out the amount you can borrow, you could be hit with a huge tax bill in a single year that would be crippling, since it would represent all your past money borrowed. Investors suggest instead that people set up IRA accounts or money market funds accounts, and purchase insurance separately that doesn’t offer a variable death benefit. The eventual cost is usually lower.
