Variable Life Insurance Pitfalls

Variable life insurance provides many of the same benefits as whole life insurance, while also giving policyholders greater investment options and the chance of higher growth in their policy’s cash value.

While variable life insurance is great in providing flexibility in investment choices and the chance of higher rewards, there are also risks involved. There are several key mistakes and pitfalls that people can encounter when buying variable life insurance.

Major variable life insurance pitfalls include:

  • Using short-term money – Variable life insurance should be considered a long-term investment. If you need the money in the next five years, don’t put it into variable life insurance.
  • Failing to diversify – Just like any investment, it’s good to spread your money among a wide range of investment types – stocks, bonds, different companies and countries.
  • Paying high fees – Different insurance companies charge different fees. Try to find the lowest investment management and administration fees – even 1 or 2 percent each year can add up to a huge difference.
  • Failing to assess your risk tolerance – Variable life insurance is for risk tolerant investors who are savvy about the market and understand that potential gain also means potential losses.  
  • Choosing the wrong insurance company – Just like any investment, policyholders need to feel confident in the strength, expertise and reputation of the insurance company selling their variable life policy.

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Using Short-term Money

Variable life insurance is not meant to be used for short-term savings. A general rule of thumb is that any money that you expect to need during the next five years should not be invested in the stock market – there’s too much risk that the market could go down before you need to withdraw your cash.

Instead, policyholders need to remember that variable life insurance is a long-term investment. Just like retirement savings or a college fund, the money in variable life insurance investment accounts is being saved for long-term goals. The stock market might go up or down along the way, but over the long term, investors in variable life insurance expect for the overall value of their accounts to grow. People who want a low-risk place to put their life insurance cash value should consider universal life or whole life insurance policies instead – these offer guaranteed cash values with fixed interest rates.

Failing to Diversify

The best life insurance companies offer a wide range of investment offerings for their variable life insurance policies – so why do so many policyholders fail to take advantage of the opportunities? Don’t put your variable life insurance investments into only one stock or bond fund. Spread the money around.

This lowers the risk that your investment will be harmed by the poor performance of any one sector of the economy, and helps ensure that you can gain from an overall rise in the market. Look for international investment opportunities as well – not only does this diversify your portfolio from too much reliance on the U.S. economy alone, but it also offers potential gain when foreign currencies get stronger against the dollar.

Paying High Fees

Some life insurance companies charge high fees to manage the investments in a variable life insurance policy – and these fees are not always easy to see or understand. Make sure you read the fine print – all of it – before signing a contract. Try to shop around and compare rates to avoid paying the highest fees for investment management.

After all, every dollar you pay in investment management fees is ultimately coming out of your long-term savings. Even 1 or 2 percent saved on fees each year can add up to thousands of dollars over the course of a lifetime.

Failing to Assess Risk Tolerance

Some people are attracted by the promise of big investment returns offered by variable life insurance – so they buy a policy, and then are horrified when the market goes down. Variable life insurance is not for the faint of heart. Investing in variable life insurance requires an honest self-assessment of your risk tolerance.

If you’re impatient with the low returns on a traditional whole life insurance policy cash value, if you’re savvy about the market and you know that stocks can go up as well as down, if you’re willing to ride the ups and downs in pursuit of bigger long-term rewards, then variable life insurance might be right for you.

On the other hand, if you can’t stand the thought of losing part of your variable life insurance investment, then a stable cash value policy like whole life insurance might be a better choice.

Choosing the Wrong Insurance Company

Just like any other investment, buying variable life insurance requires the policyholder to carefully review and evaluate the companies selling the product. Policyholders need to be confident in the financial strength and solid reputation of the company that they buy from. Beware of cold calls from insurance agents – do some independent research before deciding if variable life insurance fits with your overall portfolio.

Evaluate the financial performance of the variable life insurance investment options by reading the prospectus provided by the insurance company – good, reputable insurance companies will happily provide this information, often on their websites. You should also research the financial ratings of the insurance companies themselves. Find a company with a solid track record, steady earnings and the strength to be around for the long haul. 

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