Variable Life Insurance
Variable life insurance combines death benefit protection with investment features. Like variable annuities, the cash value is invested in a separate account and is considered a security.
Types of Life Insurance
Traditional Life Insurance (Not Securities)
Term Life
- Pure death benefit protection
- No cash value
- Premiums increase with age or are level for term period
- Most affordable coverage
Whole Life
- Permanent coverage with guaranteed cash value
- Fixed premiums
- Cash value grows at guaranteed rate
- Invested in insurer's general account
- Not a security
Universal Life
- Flexible premiums and death benefits
- Cash value tied to current interest rates
- Invested in general account
- Not a security (unless variable)
Variable Life Insurance (Securities)
Variable Life (VL)
- Fixed, scheduled premiums
- Cash value invested in separate account
- Death benefit has guaranteed minimum
- Cash value can fluctuate (no floor)
- Is a security (requires Series 6 or 7)
Variable Universal Life (VUL)
- Combines variable life with universal life features
- Flexible premiums
- Cash value invested in separate account
- Death benefit can be adjusted
- Most flexibility, most complexity
- Is a security
Variable Life Insurance Features
Separate Account Investment
- Policyholder chooses investment subaccounts
- Options similar to mutual funds (equity, bond, money market)
- Cash value depends on subaccount performance
- Policyholder bears investment risk
Death Benefit Options
| Option | Description |
|---|---|
| Level (Option A) | Face amount stays constant; cash value is included in benefit |
| Increasing (Option B) | Face amount + cash value; more expensive |
Guaranteed Minimum Death Benefit:
- Variable life guarantees a minimum death benefit regardless of cash value performance
- This guarantee is the "insurance" component
- Cash value can decline to zero, but minimum death benefit remains
Cash Value Features
| Feature | Details |
|---|---|
| Tax-deferred growth | Cash value grows without current taxation |
| Policy loans | Can borrow against cash value |
| Withdrawals | Partial surrenders allowed |
| Tax treatment | FIFO for life insurance (unlike annuities) |
Policy Loans and Withdrawals
Policy Loans
- Borrow against cash value
- No credit check required
- Interest charged on loan
- Reduces death benefit if not repaid
- Outstanding loans at death reduce benefit to beneficiaries
Cash Value Withdrawals
- Taxed on FIFO basis (cost basis first)
- Withdrawals up to cost basis are tax-free
- Withdrawals exceeding cost basis are taxable
- May reduce death benefit
- May cause policy to lapse
Important: Life insurance uses FIFO (First-In, First-Out), while annuities use LIFO (Last-In, First-Out).
Key Risks of Variable Life Insurance
| Risk | Description |
|---|---|
| Market risk | Cash value can decline with poor performance |
| Lapse risk | If cash value insufficient, policy terminates |
| Fee drag | Mortality charges, administrative fees reduce returns |
| Complexity | Difficult for many investors to understand |
What Can Happen if Cash Value Declines
- May need to pay additional premiums to keep policy in force
- Policy may lapse if insufficient cash value
- Death benefit stays at guaranteed minimum (unless lapsed)
Suitability Considerations
Variable life insurance may be suitable for:
- Long-term investors with insurance needs
- Higher risk tolerance
- Tax-advantaged wealth transfer goals
- Those who have maxed out other retirement accounts
Variable life insurance may NOT be suitable for:
- Short-term needs
- Conservative investors
- Those seeking guaranteed returns
- Primary retirement vehicle (high fees reduce returns)
Exam Tip: FIFO vs. LIFO Tax Treatment Life Insurance uses FIFO (cost basis out first = tax-free first). Annuities use LIFO (earnings out first = taxable first). This is a common exam distinction!
Which of the following is TRUE about variable annuities?
During the accumulation phase of a variable annuity, an investor purchases:
A variable annuity has an Assumed Interest Rate (AIR) of 5%. If the separate account earns 7%, the annuitant's payment will:
A 52-year-old withdraws $20,000 from a non-qualified variable annuity with $50,000 cost basis and $80,000 value. The withdrawal is subject to:
Which of the following is a permitted 1035 exchange?
Once a variable annuity is annuitized, which of the following is TRUE?
Variable life insurance differs from whole life insurance primarily because:
Which annuity payout option provides the HIGHEST monthly payment?
An investor withdraws $10,000 from a VUL policy with $40,000 cost basis and $70,000 cash value. How is it taxed?
What happens if the cash value in a variable life insurance policy declines significantly?
To sell variable annuities, a registered representative must hold:
Which is NOT an exception to the 10% early withdrawal penalty for annuities?
During the accumulation phase of a variable annuity, all of the following occur EXCEPT:
The separate account of a variable annuity is BEST described as:
An investor with a higher AIR will experience:
Which death benefit option in variable life will provide the LARGEST payout if cash value has grown substantially?