Adjustable Life Insurance: Pros & Cons of Flexible Premiums
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Adjustable life insurance is a hybrid policy that combines features of term life and whole life insurance. It is permanent insurance designed to last your entire life, as long as premiums are paid.
Also known as flexible premium adjustable life insurance, this policy has a cash value component that grows with the company's financial performance but also has a guaranteed minimum interest rate. Adjustable policies have pros and cons, but they can be a good alternative to whole life insurance if you want flexibility in case your financial needs change.
How does adjustable life insurance work?
Adjustable, or universal, life insurance works like other policies but has the added benefit of flexibility, depending on your financial scenario. The policy has a tax-free death benefit for the beneficiary, and . premiums are paid monthly or annually.
Since adjustable life insurance is a form of permanent insurance, part of the premium goes toward the cost of insurance (such as administrative fees and death benefit coverage), and part is put toward the cash value. As this cash value grows, it can be used in various ways. For example, it can be used to take out a loan or pay premiums.
Over the duration of an adjustable life policy, you can change three components: the premiums, death benefit and cash value. However, the insurance company decides when and how often you can make these adjustments.
Adjustable life insurance offers flexible cash value and premiums
Adjustable life insurance has a cash value component separate from the death benefit. If you put more money into the policy than required, the cash value will increase quicker. You can also use the cash value to pay part or all of the premiums, making your payments flexible over time.
For example, say you experience a hardship, such as a death in the family. You could pay the minimum premium — set by the insurance company — and then resume typical payments once the financial difficulty resolves. On the other hand, many people choose to pay the maximum premium during the first years of the policy, so the cash value grows quicker.
The cash value of a flexible premium adjustable life insurance policy grows based on your company's financial portfolio. As mentioned above, there is a minimum guaranteed annual interest rate. But if the company has a positive market performance, your cash value will grow at a higher interest rate. An adjustable life insurance policy's cash value can be used as:
- Surrender value: You can cancel your life insurance policy and give it back to the company. In this case, you would give up the death benefit and in return get the accumulated cash value, as a taxable gain.
- Loan: You can borrow money from the company and use the cash value as collateral. Any policy loans would come with the company's interest rate, but this is typically very low.
- Premium payments: Cash value can be used to pay all or part of the premiums. But it's important to remember that if the cash value drops to zero, the policy could lapse.
Adjustable life with an index account option
Adjustable life insurance with an indexed option is similar to a standard adjustable life policy. But the cash value growth is tied to the financial performance of an index. The interest rate will increase or decrease, based on whether the index you choose performs well or poorly.
Similar to variable life insurance, you can invest the cash value of an indexed account in different subaccounts. Index options vary by company, but common ones include the Nasdaq-100 and Russell 2000. Overall, indexed life insurance has a greater potential return than whole life insurance. But it also comes with the risk of slower growth if the index performs poorly.
What is a 7702 plan?
Permanent policies with a cash value component, such as flexible premium adjustable policies, are often called 7702 life insurance. This simply means they comply with section 7702 of the tax regulations. Life insurance has many tax advantages, including a tax-free death benefit distribution. The tax regulation created a limit on what could be classified life insurance, so other investment vehicles couldn't take advantage of the tax benefits of life insurance.
Can you change the death benefit of an adjustable life policy?
Adjustable life insurance allows you to decrease or increase the death benefit as your requirements change. If an increase is large enough, you may need an additional medical exam and pay higher premiums. With a decrease, you may be able to pay lower premiums — or have no premiums at all, if your cash value has grown enough to pay for the policy.
Say your children are self-sufficient and no longer dependent on you. You may not need a large death benefit. You could decrease the face value of an adjustable life insurance policy to accurately cover your needs and lower ongoing payments.
What makes adjustable life insurance different from other kinds of life insurance?
Adjustable life insurance differs from other policies in that it is customizable and can change with your financial needs. Here's how adjustable life insurance compares to other popular insurance products.
Adjustable life vs. whole life insurance
Whole life insurance offers less flexibility than adjustable life insurance. Whole life has a guaranteed fixed interest rate on its cash value. This means that even if the company's portfolio does well, you'll still only get the fixed interest rate. So you may lose out on potential gains with a whole life policy.
On the other hand, when the company performs badly, the interest rate on an adjustable life policy may be lower than the guaranteed rate offered by whole life insurance.
Whole life insurance can be beneficial if you want a simpler product with slightly cheaper rates. Premiums are guaranteed to stay the same. This can be comforting if you want life insurance but don't want to worry about the policy costs changing later.
Adjustable life vs. variable life insurance
Variable life and adjustable life are both forms of permanent insurance, but the primary difference is in how the cash value grows. As mentioned above, adjustable life policies have a minimum interest rate, but your cash value can increase quicker, depending on the company's financial performance. For variable life, your interest rate depends on the investment categories you select from a list, which can be tied to stocks, bonds, treasury bills and other investment securities.
Since you are selecting the mode of cash value growth, there is typically no guaranteed minimum interest rate. So variable life insurance can have an interest rate that is close to zero and significantly less than an adjustable life policy's. This is how variable life insurance is a more risky investment product than more stable policies like whole and adjustable life insurance.
What are the pros and cons of adjustable life insurance?
Flexible premium adjustable life insurance can be appealing if your coverage needs may change the future. The ability to adjust policy components can be useful. For example, if you are expecting to have a child, then you may need more insurance. With adjustable life insurance, you could easily increase premiums and the policy's face value to cover the added need.
Adjustable premium life insurance is also attractive if you want to adjust premiums based on your financial situation. For instance, if you're currently a high earner and want to minimize costs in retirement, you can overfund an adjustable policy during the first several years and then use its cash value to pay premiums later.
But flexible premium and other permanent insurance policies can be costly, because cash value insurance comes with a higher premium. This is an important factor when deciding what type of life insurance to buy.
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