Variable Death Benefit

Variable Death Benefit

A variable death benefit is the portion of a variable universal life (VUL) insurance payout that varies with the performance of the policy’s investment (cash value) account. In a VUL policy, premiums fund both the insurance protection (the guaranteed face amount) and an investment account that can be allocated among the insurer’s offered funds (equities, bonds, money market, etc.). The total death benefit equals the guaranteed face amount plus the cash value when the policy’s benefit option is the variable (increasing) death benefit.

How it works

• Policyholder allocates premium dollars to a cash-value account invested in the insurer’s offered funds.
• Investment returns (positive or negative) change the cash value.
• Under the variable death benefit option, the insurer pays the face amount plus the cash value to beneficiaries (subject to policy terms).
• Policy loans or withdrawals reduce the death benefit.
• Investment gains inside the policy grow tax-deferred; life insurance proceeds are generally paid income-tax-free to beneficiaries.

Note: The variable death benefit is often called an “increasing benefit,” but the cash value can also decline if investments perform poorly.

Pros

• Potential for higher returns than fixed insurance because cash value is invested in equities or other higher-return assets.
• Investment flexibility—policyholders can usually change underlying allocations.
• Investment gains inside the policy are tax-deferred while they remain in the account.
• Death benefit can increase with favorable market performance.

Cons

• Investment risk—cash value can decline, reducing the total death benefit.
• Higher costs and fees (management, administrative, mortality charges) than term life or level death benefit options.
• Complex product—requires ongoing management and understanding of investments and fees.
• Risk of policy lapse if cash value is insufficient to cover charges.
• Total long-term premiums and fees can be substantially greater than term insurance.

When to consider a variable death benefit

• You want permanent life insurance plus exposure to investment returns.
• You accept market risk and higher fees in exchange for potential upside.
• You can monitor and fund the policy to avoid lapses.
• Younger buyers who prefer equity exposure for long-term growth may find this more appealing; older buyers may prefer more conservative allocations.

Alternatively, some individuals choose to buy term life (which is much cheaper) and invest the difference separately.

Example

Anna pays a $50,000 premium into a VUL policy. She allocates $30,000 to an equity fund and $20,000 to a bond fund. Both funds earn 5% over a year, so the cash value grows from $50,000 to $52,500. After a $2,000 annual administrative fee, the cash value is $50,500. If the policy’s guaranteed face amount is $100,000 and the variable death benefit option applies, the total death benefit would be $100,000 (face) + $50,500 (cash value) = $150,500. If Anna had borrowed against the policy or if investments fell in value, the total payout would be lower.

Key takeaways

• A variable death benefit ties part of the life insurance payout to investment performance inside a VUL policy.
• It offers upside potential but exposes the policy’s death benefit to market risk and higher fees.
• Evaluate fees, investment options, and the risk of policy lapse before choosing this option.

Sources: Internal Revenue Service; U.S. Securities and Exchange Commission.