Adjustable Life Insurance: Pros & Cons of Flexible Premiums
Adjustable life insurance is a hybrid policy that combines features of term and whole life insurance. An adjustable life policy is a type of permanent insurance that is intended to last as long as premiums are paid into the plan.
The policy, also known as flexible premium adjustable life insurance, has a cash value component that grows with the insurer's financial performance but has a minimum guaranteed interest rate. Adjustable policies have advantages and disadvantages, but they can be a good alternative to whole life insurance if your financial needs change.
How does adjustable life insurance work?
Adjustable life insurance, also known as universal life insurance, functions similarly to other life insurance products but has the added benefit of flexibility, depending on your financial situation. The policy includes a death benefit that is tax-free to a beneficiary if the insured dies, and premiums can be paid monthly or annually.
Because adjustable life insurance is a type of permanent insurance, a portion of the premiums are applied to the cost of insurance (such as administrative fees and death benefit coverage), while the remainder is applied to the cash value. This cash value can be used in a variety of ways as it grows in value. It can be used to obtain a loan or to pay for premiums, for example.
You can change three aspects of your coverage during the life of an adjustable life policy: the premiums, death benefit, and cash value. However, the insurer determines when and how frequently you can make these changes.
Adjustable life insurance offers flexible cash value and premiums.
Adjustable life insurance includes a cash value component in addition to the death benefit. If you put more money into the policy than is required, the cash value will rise faster. You can also use the cash value of your adjustable life insurance policy to pay a portion or all of your premiums, making your payments more flexible over time.
For example, if you face a financial hardship, such as a death in the family, you could pay the insurer's minimum premium during one period and then resume regular payments once the hardship has passed. Many people, on the other hand, choose to pay the maximum premium during the first years of the policy in order for the cash value to grow as quickly as possible.
A flexible premium adjustable life insurance policy's cash value grows based on the interest rate of your insurer's financial portfolio. As previously stated, there is a minimum annual interest rate that is guaranteed to increase the value of your cash. However, if the insurer outperforms the market, your cash value will grow at a higher rate of interest. The cash value of an adjustable life insurance policy can be used to:
- Surrender value: A life insurance policy can be canceled and returned to the insurer. In this case, you would "surrender" the death benefit in exchange for the accumulated cash value, which would be taxable.
- Loan: You can borrow money from your insurer and use the cash value as collateral. Policy loans are subject to the insurer's interest rates, which are typically very low.
- Premium payments: Cash value can be used to pay all or part of the policy's premium. It is critical to remember that if the cash value falls below zero, the policy may 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 linked to an index's financial performance. If the index you chose performs well or poorly during a period, the interest rate will rise or fall.
An indexed account is similar to variable life insurance in that the cash value can be invested in various subaccounts. Each insurer selects its own indexes, but popular choices include the Nasdaq-100 and the Russell 2000. Overall, indexed life insurance offers a higher potential return than whole life insurance, but it also carries the risk of slower growth if the underlying index performs poorly.
What is a 7702 plan?
7702 life insurance refers to permanent life policies with a cash value component, such as flexible premium adjustable policies. This simply means that they are in accordance with section 7702 of the tax regulations for life insurance. Life insurance provides numerous tax benefits, including a tax-free death benefit distribution. The tax regulation established a limit on what could be classified as a life insurance product, preventing other investment vehicles from reaping the tax benefits of life insurance.
Can you change the death benefit in an adjustable life policy?
Adjustable life insurance allows you to change the death benefit as your coverage needs change. If the increase is significant enough, you may be required to take an additional medical exam and pay higher premiums. In the event of a decrease, you may be able to pay lower premiums or no premiums at all if your cash value has grown sufficiently to cover the cost of the policy.
Assume your children are all self-sufficient and no longer reliant on you. You may not require a large death benefit at that point. With an adjustable life insurance policy, you can reduce the face amount to more accurately cover your needs and lower ongoing payments.
What makes adjustable life insurance different from other kinds of life insurance?
Adjustable life insurance is distinct from other types of life insurance policies in that it is tailored to your specific needs and can evolve in response to changes in your financial situation. We've compared adjustable life insurance to some of the most popular insurance products below.
Adjustable life vs. whole life insurance
Whole life insurance, as opposed to adjustable life insurance, provides less flexibility. The cash value of a whole life policy grows at a guaranteed fixed interest rate. This means that you will only receive the fixed interest rate even if the insurer's portfolio performs well.
When compared to an adjustable life policy, which has an interest rate that can rise if the insurer performs well, a whole life policy may miss out on potential gains. When the insurer performs poorly, however, the interest rate for an adjustable life policy may be lower than the guaranteed rate offered by whole life insurance.
If you want a simpler product with slightly lower rates, whole life insurance can be advantageous. Whole life policies have constant premiums that are guaranteed to remain constant. This can be reassuring to people who want to buy life insurance but are concerned about the policy costs changing later in life.
Adjustable life vs. variable life insurance
Variable life insurance and adjustable life insurance are both types of permanent insurance, but the main difference is how the cash value grows. Adjustable life policies, as previously stated, have a minimum interest rate, but your cash value can increase more quickly depending on the insurer's financial performance. In the case of variable life, your interest rate is determined by the investment categories you choose from a list provided by your insurer. This can include investment categories based on stocks, bonds, treasury bills, and other financial instruments.
Because you have chosen the mode of cash value growth, there is no guaranteed minimum interest rate. As a result, variable life insurance can have interest rates close to zero and significantly lower than an adjustable life policy. This is how variable life insurance differs from more stable policies like whole and adjustable life insurance in terms of investment risk.
What are the pros and cons of adjustable life insurance?
Variable premium If you anticipate changing coverage needs in the future, adjustable life insurance may be appealing. In an insurance policy, the ability to change policy components based on your financial situation or future goals can be beneficial. For example, if you are expecting a child, you may realize you require additional insurance. If you had adjustable life insurance, you could easily raise premiums and the policy face value to compensate for the increased need.
If you want to be able to adjust your premiums based on your financial situation, adjustable premium life insurance is another option. For example, if you're a high earner now and want to reduce your retirement costs, you can overfund an adjustable policy during the first few years of coverage and use the cash value to pay premiums later.
However, because cash value insurance has a higher premium, flexible premium policies and other permanent insurance policies can be costly. This is an important consideration when deciding on the type of life insurance to buy.