The basics: your cash buys mutual fund shares, not a savings account

A variable life policy investment account does not earn interest like a bank account. Instead, the money you pay into the policy buys shares of mutual funds you choose from a menu the insurance company provides. The account grows or shrinks based on how those funds perform in the stock and bond markets. If the funds go up in value, your account goes up. If they go down, your account goes down—and so does your policy's cash value.

This is the core difference between variable life and whole life insurance. Whole life policies have a may provide cash value that grows at a rate set by the insurance company. Variable life policies have no may provide. Your returns depend entirely on the investment choices you make and how those markets behave.

Key Takeaways

  • Your premium dollars buy mutual fund shares, not may provide interest, so your account value moves with stock and bond market performance.
  • You choose from a limited menu of mutual funds offered by your insurance company, typically ranging from conservative bond funds to aggressive stock funds.
  • The insurance company deducts fees for administration, mortality costs, and fund management before you see any gains.
  • Your policy's death benefit can increase if your account grows, but it can also decrease if markets fall and your cash value drops below a minimum threshold.
  • You can borrow against your cash value or withdraw money, but doing so reduces the death benefit and may trigger tax consequences.

How the money actually moves: premiums to funds to your account

When you pay your premium, the insurance company takes out its fees first. These cover the cost of insuring you (mortality risk), administrative overhead, and fund management expenses. What remains goes into the mutual funds you selected. If you chose 60 percent in a stock fund and 40 percent in a bond fund, that split applies to every dollar that reaches the investment account.

The mutual funds themselves hold portfolios of stocks, bonds, or both. As those holdings gain or lose value, the share price of each fund changes. Your account value is straightforward the number of shares you own multiplied by the current share price. If a stock fund you own rises 8 percent in a year, your shares in that fund are worth 8 percent more. If a bond fund falls 2 percent, your shares in that fund are worth 2 percent less.

This happens continuously. You do not have to do anything. The account updates as markets move, usually daily or weekly depending on how often the insurance company values the funds.

The fees that eat into your growth

Variable life policies charge multiple layers of fees, and they all reduce what you actually earn. The most visible is the fund expense ratio—the annual cost to manage each mutual fund, usually between 0.5 and 2 percent per year. A 1 percent expense ratio means that if a fund gains 7 percent, you keep 6 percent.

Beyond that, the insurance company charges a mortality and expense (M&E) fee, typically 0.75 to 1.5 percent annually. This covers the cost of insuring you and administrative overhead. Some policies also charge a policy administration fee, a flat dollar amount each year, often $50 to $100.

These fees compound over time. On a $100,000 account with 1.5 percent in total annual fees, you lose $1,500 per year before any market gains or losses. Over 20 years, that compounds into a significant drag on growth, even in a rising market.

When your account grows faster than expected: market gains and rebalancing

If you choose aggressive funds heavy in stocks, your account can grow substantially during bull markets. A 10 percent annual return on a $100,000 account means $10,000 in gains per year (before fees). Over time, compound growth accelerates—your gains earn gains.

However, most variable life policies allow you to rebalance your fund allocation, meaning you can shift money between funds. If your stock funds have grown to 75 percent of your account but you want to stay at 60 percent, you can move the excess into bond funds. Rebalancing locks in gains but also forces you to sell high and buy low, which is disciplined but not automatic.

Some policies offer a rebalancing service that automatically adjusts your allocation back to your target mix, usually once or twice per year. This prevents your account from drifting too far toward whichever funds performed best, which can leave you overexposed to risk.

When your account shrinks: market losses and their impact on your death benefit

Variable life policies expose you to real downside risk. If your account is heavily invested in stocks and markets fall 20 percent, your cash value falls 20 percent too (minus fees). A $100,000 account becomes $80,000. This is not a temporary dip on paper—it is real money gone from your policy.

This matters because your death benefit is tied to your cash value. Most variable life policies have a minimum death benefit may provide regardless of account performance, but if your cash value falls significantly, your actual death benefit may drop to that minimum. If you bought the policy expecting a $500,000 death benefit and your account loses 40 percent, your beneficiary might receive only $250,000 or whatever the may provide minimum is.

Worse, if your account value falls too far, you may need to pay higher premiums to keep the policy in force. The insurance company charges a mortality cost based on your age and risk, and if your cash value is not covering that cost, you have to make up the difference out of pocket or the policy lapses.

Loans and withdrawals: accessing your money and the consequences

Most variable life policies let you borrow against your cash value at a stated interest rate, often 6 to 8 percent. You do not have to pay the loan back—it straightforward reduces your death benefit and the cash value available to your heirs. If you borrow $20,000 against a $100,000 account, your death benefit drops by at least $20,000 plus accrued interest.

You can also withdraw money directly, though this is less common. Withdrawals reduce your cash value permanently and may trigger income tax on any gains above what you paid in premiums. The insurance company may also charge a surrender charge if you withdraw during the first 10 to 15 years of the policy—a penalty that can be 5 to 10 percent of the amount withdrawn.

Both loans and withdrawals reduce the death benefit your beneficiaries receive, so they should be treated as last resorts, not as a way to access cheap money.

How your choices shape growth: asset allocation and risk tolerance

The single biggest factor in how your account grows is your choice of funds. An account invested 100 percent in a stock index fund will grow faster than one invested 100 percent in a bond fund during rising markets, but it will also fall faster during downturns. An account split 50-50 between stocks and bonds will be somewhere in the middle.

Insurance companies typically offer a range of options: conservative (mostly bonds), moderate (balanced mix), and aggressive (mostly stocks). Some also offer target-date funds that automatically shift from stocks to bonds as you approach a certain age. Choosing the right mix depends on your age, how long you plan to keep the policy, and how much volatility you can tolerate.

Many people choose too conservatively because they think of insurance as safe. But if your account is mostly in bonds earning 3 percent per year while you are paying 1.5 percent in fees, your real return is only 1.5 percent—barely ahead of inflation. Over 30 years, that compounds into much less wealth than a more balanced approach would have built.

Frequently Asked Questions

Can my variable life account go to zero?

Your account value can fall dramatically, but the insurance company guarantees a minimum death benefit. However, if your cash value falls too far, you may have to pay higher premiums to keep the policy in force, or the policy may lapse entirely if you cannot afford the premiums.

What happens if I do not choose which funds to invest in?

Most insurance companies assign you a default fund, usually a conservative balanced fund, if you do not make an active choice. You can change your allocation at any time, typically by calling the company or logging into your online account.

Are the mutual funds in a variable life policy the same as ones I could buy on my own?

They are similar but not identical. The funds offered through your policy are usually versions of well-known funds, but they may have slightly higher expense ratios because the insurance company adds its own layer of fees on top. You are also limited to the menu the insurance company provides.

How often should I review my account and rebalance?

Most financial advisors suggest reviewing your allocation once or twice per year. If one fund has grown to significantly more than your target percentage, rebalancing brings it back in line. Some policies offer automatic rebalancing, which removes the need for you to act.

What if I want to switch to a different insurance company?

You can surrender the policy and move to another, but you may owe income tax on any gains and face surrender charges if the policy is still in its early years. A better option is often to keep the policy and straightforward stop paying premiums if you no longer want it, letting the cash value cover costs until it runs out.