Variable Death Benefit: Meaning, Pros, and Cons, Example

What Is a Variable Death Benefit?

A variable death benefit is the amount paid to a decedent’s beneficiary based on the performance of an investment account within a variable universal life insurance policy. This amount is in addition to a guaranteed death benefit that remains constant.

Policyholders of variable universal life insurance can choose from various investment options offered by their insurer, including equity and fixed-income mutual funds. The variable amount, or cash value, together with the guaranteed death benefit, known as the face value, forms the total death benefit.

Understanding Variable Death Benefit

A variable death benefit is one of three options available with variable universal life insurance policies, alongside a level death benefit and a return of premium benefit. None of these benefit types are taxable to the beneficiary, and borrowing against the policy reduces the death benefit.

The variable death benefit can also be referred to as an increasing benefit, despite the fact that the cash value can either increase or decrease depending on investment performance.

Key Takeaways

• A variable death benefit is the amount paid to a decedent’s beneficiary from a variable life insurance policy’s investment account.
• Variable life insurance policies allow investment in stocks or equity mutual funds for potentially higher returns.
• Variable life insurance policies have associated management fees that affect the variable death benefit.

Pros and Cons of Variable Death Benefit

Investors are offered various securities and funds by life insurance companies, including stocks, bonds, and money market funds. Each option has management and administrative fees. Variable life insurance policies allocate a portion of the premium paid to cash value accounts for investing in these equity instruments.

A variable death benefit that invests mainly in stocks or equity mutual funds may be attractive to younger investors looking for a long-term investment vehicle. Bonds may be more suitable for older investors.

Variable death benefits allow changes to the underlying investments over time. Policyholders receive the full return of the underlying investment, minus fees.

A variable death benefit may cost less than a return of premium benefit over time, and it offers tax benefits as gains are eligible for deferred tax until the death benefit is claimed.

However, a variable death benefit is usually more expensive than a level death benefit and may have additional costs. Higher death benefits result in higher premiums, and insufficient funds may cause a policy to lapse due to administrative costs.

Cost differences can be significant, as the total premiums of the three main types of variable universal life benefits can differ by thousands of dollars over the policy’s lifetime.

Consumers should carefully evaluate the pros and cons of variable universal life insurance. This type of insurance offers non-expiring coverage as long as premiums are paid and allows flexible premiums. However, it is typically more expensive than term insurance, which lacks an investment component.

Example of a Variable Benefit

Shinzo has invested $50,000 annually in a variable life insurance policy. He allocates $30,000 to an equity mutual fund and the remaining to a bond fund. The mutual fund and bond fund produce a 5% return the following year, bringing the account value to $32,500. With an annual administrative fee of $2,000, Shinzo’s beneficiary is eligible for a total death benefit of $30,500 at the end of that year.