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Adjustable Life Insurance: The Real Cost of Flexibility

Adjustable life insurance is often referred to as a hybrid of term and whole life insurance. It’s permanent, provided premiums are paid, so you don’t have to worry about losing coverage as you get older. And it features a cash value component that can be used in the form of tax-free policy loans or even to pay insurance premiums. You can increase or decrease premiums and coverage amounts if your financial situation changes. 

At a glance, adjustable life insurance seems like an ideal permanent life insurance product: lifetime flexibility + guaranteed coverage + cash value. But there are significant risks associated with adjustable life policies you need to be aware of before you buy. how does it stack up against other types of permanent life insurance? And what hidden risks come with increased flexibility?

In this article, we’ll discuss how adjustable life insurance compares to other policy options in terms of risk and outline the pros and cons of each to help you find the best type of life insurance for your financial goals. 

PERMANENT LIFE INSURANCE: THE BASICS

Permanent life insurance is designed to provide the policyholder coverage for life, unlike term life insurance, which is purchased for a specified number of years. When you pay a policy premium into a permanent life insurance policy, part of it goes toward covering the policy’s death benefit and any administrative fees. The balance is credited toward the policy’s cash value—a built-in savings account that can grow wealth over time. 

The cash value of permanent life insurance may be withdrawn (taxable) or borrowed (tax-free) for any reason, at any time. Further, you can use cash value to pay insurance premiums. It’s liquid and there are no penalties for utilizing it, however your insurance company will charge a low interest rate if you access it via policy loan. You determine the payback term of a policy loan.

Common uses of cash value include funding outside investments, paying for childrens’ college education, business capital, real estate, and even retirement income. When you pass away, your beneficiary usually doesn’t receive your cash value, as it’s a reflection of the death benefit amount. They do, however, receive a death benefit that is tax-free and not subject to probate. Depending on your insurance policy, your death benefit may also be excluded from estate taxes and gift taxes. 

A UNIVERSAL LIFE INSURANCE POLICY BY ANY OTHER NAME…

When people talk about adjustable life insurance, they’re usually referring to universal life insurance. Premiums are flexible and you can determine your payment schedule, whether it’s monthly, quarterly, or annually. Your policy is tied to the financial performance of your insurer through various investments that affect the growth of your cash value. Your insurer may or may not offer an additional guaranteed rate of return. Usually, insurance companies guarantee at least a 0% rate of return, meaning you won’t lose cash value if investments underperform. 

Here are the key risks associated with adjustable life insurance:

  • Gains are tied to the financial performance of your insurer
  • Depleting your cash value may result in terminating your policy
  • Cash flow is unpredictable
  • Premium costs may increase
  • Adjustable policies tend to have the highest premiums
  • There may be limits to coverage increases
  • Changes in health could affect future insurability

In years your insurance company performs well, you may see substantial gains in your policy’s cash value. However, if your insurance company underperforms, your cash value will accumulate very slowly. This uncertainty can be problematic if you’re relying on your cash value to pay some or all of your insurance premiums. Further, if your financial goals involve using tax-free policy loans or withdrawals to pay for outside investment opportunities, college education, business capital, real estate, or retirement, it can be difficult to predict cash flow. 

Some people gravitate toward adjustable life insurance because they can increase coverage amounts down the road as their insurance needs increase, like after a marriage, birth of a child, or major financial purchase. Likewise, it’s possible to decrease coverage when you pay off large debts, your kids grow up, or in the event you become unemployed or experience a significant change in income. 

Overall, adjustable life insurance tends to have the highest premiums. Changes in coverage will reflect a change in premiums, but be aware that your insurance company has the ability to increase premiums at their discretion, regardless of whether or not you’ve adjusted your policy. 

It’s also worth noting that not all policies offer unlimited changes in coverage. In some cases, if you decrease coverage, you’re ineligible to increase it again at a later date. Further, increases in coverage, regardless of when they happen, are often subject to additional underwriting and may require another medical exam. Changes in health can affect your insurability.

ADJUSTABLE LIFE INSURANCE VS. VARIABLE LIFE INSURANCE

Adjustable life insurance and variable life insurance may sound the same, but the two policies can have vastly different levels of risk. 

Here are the key risks associated with variable life insurance:

  • Gains are tied to market-based investments
  • There is usually no guaranteed rate of return
  • Variable policies tend to have the highest management/administrative fees
  • Insurance companies may cap gains
  • Cash flow is unpredictable

With a variable life insurance policy, you can choose from various SEC-regulated sub-accounts in which to invest your cash value, like money market accounts, stocks and bonds, or other mutual-fund types of accounts. Usually, you have no guaranteed rate of return, so growth of cash value is based solely on premiums paid and performance of sub-accounts. These sub-accounts typically charge additional management fees that factor into your premium payments, which may or may not be flexible, depending on your policy.  Even in periods your investments perform well, your insurance company may cap gains or only credit a certain percentage to your cash value.

Variable life insurance is best utilized by individuals who have maxed out other investment options, have sufficient insurance coverage elsewhere, and are looking for additional coverage with an appetite for market-based risk. 

ADJUSTABLE LIFE INSURANCE VS. WHOLE LIFE INSURANCE

Whole life insurance offers the most guarantees and least risk of any kind of permanent life insurance policy. It offers the highest guaranteed rate of return, and policies underwritten by mutual insurance companies are also eligible to earn non-guaranteed dividends. For individuals looking to use their cash value for outside investments, college education, business capital, real estate, or retirement, whole life insurance makes it easy to predict future cash flow.

Whole life insurance doesn’t offer flexible premiums, and most decisions regarding coverage need to be decided when the policy is purchased. For individuals with unpredictable incomes, this can be an issue. But for many people, fixed premiums are a benefit, as it’s easier to budget for, particularly with the guaranteed rate of return offered. 

Cash value in a whole life insurance policy may be used to pay premiums and non-guaranteed dividends can purchase additional coverage in the form of paid-up additions without the need for another medical exam or underwriting. If an individual has temporary insurance requirements that don’t require lifetime coverage, like a mortgage or business loan, it’s possible to add term insurance to a whole life insurance policy, often at a better rate than if the policies were separate. 

COMPARING LIFE INSURANCE AT A GLANCE


Adjustable LifeVariable LifeWhole LifeTerm Life
PremiumsAdjustableFixed/Adjustable*FixedFixed
Cash ValueGuaranteed*Non GuaranteedGuaranteed**N/A
DurationPermanentPermanentPermanentTerm
Policy LoansTax-FreeTax-FreeTax-FreeN/A
WithdrawalsTaxableTaxableTaxableN/A
Death BenefitAdjustableFixed/Adjustable*Fixed†Fixed
Cost$$$$$$$$$$$
Fees$$$$$$$$$$

* Depends on policy/insurer

** Plus non-guaranteed dividends

† Can increase with paid-up additions

IS ADJUSTABLE LIFE INSURANCE RIGHT FOR YOU?

In most cases, there are better alternatives to adjustable life insurance. 

If you’re looking for the benefits of cash value and permanent coverage, whole life insurance is usually a more affordable choice and it comes with more guarantees. You can also add an affordable term policy for additional temporary coverage. The option of utilizing paid-up additions not only increases coverage, but allows you to more rapidly grow your wealth.

If you’re looking for low premium payments, term life insurance is the least expensive policy type. Although it doesn’t offer permanent coverage, you can purchase a convertible term policy, which allows you to convert your term life insurance to whole life insurance at a later date. This option is good for individuals who need immediate coverage on a budget, but who predict greater income in the future as their careers advance.

One exception is if you have lifelong dependents—like children with special needs—but fluctuating income, where permanent coverage is necessary but committing to fixed payments may not be feasible. In this instance, an adjustable life insurance policy might be your best option. 

At Paradigm Life we can customize a policy to fit your financial situation. Our expert Wealth Strategists are available to answer your questions and show you customized illustrations, outlining an individual plan of action to help you achieve your goals. Request a free virtual consultation, no strings attached.

 

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