Universal life insurance is a type of permanent life insurance, which is intended to last for the lifetime of an insured person rather than for a preset number of years like term life insurance. As long as you pay the premiums and sufficiently keep the policy funded, your life insurance coverage will remain active. If you pass away while the policy is active, those that you’ve named as your beneficiaries will receive the death benefit.
A universal life insurance policy also has a cash value component. When you pay your premiums, a portion of the money goes to cover the cost of the insurance while the remainder accumulates with interest as the cash value portion of the policy. During your lifetime, you may choose to withdraw or borrow money from the accumulated cash value, though each policy may have limitations on how this can be done.
How Does Universal Life Insurance Work?
Premium Flexibility
Universal life insurance is sometimes known as adjustable life insurance because of its flexibility. Policyholders may be able to raise or lower their premiums within the parameters set by the policy, meaning you could choose to pay less in premiums during times when you need your money to pay for something else, and choose to pay more when you have more income.
Policyholders may choose to make higher premium payments and have the excess added to the policy’s cash value, allowing it to grow faster. But choosing to adjust your premium for too high for too long could result in your policy becoming overfunded, which could have negative tax consequences.
Alternatively, policyholders may choose to make lower payments or even skip payments altogether if the policy has accumulated enough cash value to cover the base premium cost. But paying too little for too long could result in the policy becoming underfunded and in danger of lapsing early.
Death Benefit Flexibility
The death benefit amount is typically set when a life insurance policy is issued, but some universal life policies also allow policyholders to decrease or increase the death benefit as needed. This could help policyholders better reflect changes in their circumstances or their beneficiary’s circumstances, though insurers may require a medical exam before increasing the death benefit.
Cash Value Growth
When you pay your universal life insurance premiums, a portion of the money goes to an interest-earning cash value account. This grows on a tax-deferred basis, meaning the interest earned is taxed when you withdraw the money, but not while it’s growing.
Earned interest may be credited to the cash value account on a regular schedule. How long it takes for the account to grow depends on the rate of return, which can vary. In some cases, the insurer sets a guaranteed rate of return for the life of the policy, while other policies may set the rate of return based on the performance of a stock market index.
As the cash value accumulates, a policyholder can choose to withdraw money or borrow against the balance. This cash could be used for help with medical payments or even supplemental retirement income. For example, some retirees may tap into their policy’s cash value to help bridge the years between their retirement and when they turn 70 years old and become eligible for a higher Social Security benefit.
The cash value account is a basic living benefit for universal life insurance policyholders, but it does not have to be used in that way. Some insurers may offer a rider option that allows the cash value to increase the death benefit rather than accumulate as a living benefit.
Types Of Universal Life Insurance
The main types of universal life insurance are traditional, guaranteed, indexed, and variable. When comparing these options, consider your financial situation and your family’s needs.
Traditional or Non-Guaranteed Universal Life Insurance
Traditional universal life insurance combines a lifelong death benefit with a cash value component. These policies are also known as non-guaranteed universal life insurance because policyholders may pay higher premiums as they get older, and in some situations, the policy may lapse if underfunded or if too much cash value is withdrawn.
A traditional universal life insurance policy’s cash value may increase over time. Policyholders could use this cash value for many purposes, including paying for their life insurance premiums. When withdrawing or borrowing from the policy’s cash value, however, it’s important to monitor the balance. If the cash value is depleted, the policy can lapse, causing your life insurance coverage to end. In this situation, any loans taken out against the cash value may be taxed as income if the amount borrowed exceeds the premiums paid into the policy.
This type of policy may be a good option for someone who wants the flexibility of universal life insurance, and is also comfortable with the risk of premium increases or policy lapses.
Guaranteed Universal Life Insurance (GUL)
This type of policy is also known as “no-lapse guaranteed universal life insurance,” and is an alternative to traditional universal life insurance. With a GUL policy, the insurer guarantees that the death benefit remains in effect as long as the policyholder pays the premiums.
When you buy a GUL policy, you select an end date for the coverage, such as when you reach a certain advanced age. The premium payments can remain the same for the lifetime of the policy, offering predictable budgeting, and the death benefit amount can also be set at a fixed amount.
Unlike other types of universal life insurance policies, a GUL policy may not include a cash value component, which helps make it one of the most affordable long-term life insurance options. This type of policy may be a good option for those who want a guaranteed death benefit to cover final expenses and give to their beneficiary, but who are not necessarily interested in gaining value through cash accumulation.
In addition, if your needs change and you no longer want a GUL policy, you could surrender it. Some insurers offer a return-of-premium rider that lets policyholders cancel their policy and receive a partial or full refund of their premium payments. Consider asking about rider options before buying a policy.
Indexed Universal Life Insurance (IUL)
Indexed universal life insurance offers a lifelong death benefit and a cash value component. The rate of return on the policy’s cash value may be tied to the performance of a stock market index.
Like other permanent policies that offer cash value, a portion of your premium payments go to a cash value account. This account earns interest based on the performance of a stock market index, such as the S&P 500. As the index moves up or down, so does the rate of return on the policy’s cash value account. Insurers may set a minimum guaranteed rate of return, as well as a cap on returns.
While the cash value account isn’t actually invested in the stock market index, there’s still some risk. If the index performs poorly, the rate of return on the cash value account may be low. Although you cannot lose cash value in the policy once it’s earned, if the account performs poorly and gains are minimal or nonexistent, it’s possible that policy charges could surpass the cash value and deplete it completely.
Because of its dependency on the stock market index, IULs may be a good option for those who need permanent life insurance and are comfortable taking some risks with their cash value account.
Variable Universal Life Insurance (VUL)
A variable universal life insurance policy features an adjustable death benefit and an investable cash value account. This policy gets its name from the variable returns that policyholders may get from their investments. With a VUL policy, you can invest the cash portion of your policy in the subaccounts of your choice. These work like mutual funds, which are professionally managed pools of money that are invested in stocks, bonds, and other securities.
Depending on a policyholder’s investment choices, there is a potential for good returns on the policy’s cash value. However, there’s also a risk of poor returns and reduced cash value, and the fees may be higher than other types of universal life insurance.
Because of its hands-on investment nature, a VUL policy may be best suited for seasoned investors who need permanent life insurance and also enjoy actively managing their investments. On the other hand, those who are risk-averse or prefer passive investments may not be attracted to a VUL policy.
Universal Life vs. Whole Life Insurance
Whole life insurance is another type of permanent life insurance. Like universal life insurance, whole life insurance combines lifetime coverage with a cash value component. However, there are some key differences between these two types of permanent life insurance.
Whole life insurance policies have a fixed premium and a fixed death benefit. This means the premium payments remain the same for the life of the policy, as does the amount of the death benefit your loved ones receive. With universal life insurance policies, you may have the flexibility to adjust both your premiums and your death benefit.
Who Should Consider Universal Life Insurance?
Those looking for lifelong coverage, more flexibility in premium payments, and potential flexibility in the death benefit amount could find universal life insurance options appealing. When looking into which type of universal life insurance policy would be best for you, consider your financial and family situation, as well as your comfort level with taking investment risks with your cash value.
Lifetime Coverage
Universal life insurance policies can provide coverage for the rest of your life. While whole life insurance policies could help achieve the same goal, their premiums and death benefits are fixed, and premiums for a whole life policy are generally higher than those of a universal life policy. Those who want the option to raise or lower their premiums and death benefit in the future may prefer a universal life insurance policy that allows these changes.
Long-term Savings Goals
The cash value component of a universal life insurance policy can form part of your long-term savings strategy. You can withdraw or borrow this cash for anything you like, from renovating your home to funding your grandchild’s college education. The cash value could also help supplement your retirement income. However, it is critical to keep an eye on the balance to avoid underfunding your policy.
How to Buy Universal Life Insurance
Choose the type of policy you want
Review the features and benefits of each type of universal life insurance. Carefully consider your family’s needs in the event of your death and your financial circumstances, as well as how much risk you are willing to take for your cash value growth.
Research insurance companies
Search for insurance companies that offer the type of policy you want, but know that not all insurers are the same. Before buying a policy, consider the financial strength of the companies, as you do not want to purchase life insurance from a company that could close down, leaving you without coverage or the money you had paid into it. Several independent agencies provide this information.
Compare quotes from multiple companies
Universal life insurance premiums may vary from one insurer to another. To find a policy that suits your budget, compare quotes from multiple insurers as well as policy details.
Consult with a financial advisor or insurance agent
Universal life insurance could offer lifetime coverage and the opportunity to work toward long-term savings goals. Whether it’s a good option for you may depend on what you need and want from your life insurance policy. For help determining if universal life insurance makes sense for you talk to a licensed life insurance agent and compare your options.