What Is Universal Life Insurance?
Universal life (UL) insurance is a type of permanent life insurance coverage that guarantees a death benefit so long as the premiums are paid. Unlike term life insurance, once you enroll in the policy, it stays in place without needing to reapply or undergo additional medical underwriting.
What truly sets Universal policies apart is the built-in savings component, known as cash value. The policy owner can access this cash value during their lifetime by taking withdrawals or using policy loans.
These policies also offer flexible premiums and the option to adjust the death benefit. For example, the policy owner may be able to pay a lower premium amount or even stop paying premiums for a certain amount of time while still keeping the policy in force. It’s also possible to adjust the policy’s death benefits as your needs change.
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An Option for Individuals Seeking Flexibility
Approximately 106 million adults in the United States are underinsured or do not have any life insurance coverage. Recent surveys have pointed to cost as the primary reason individuals elect to forgo life insurance coverage.
However, cost is not the only reason. In that same survey, lack of knowledge on what kind of policy to get and lack of knowledge of how much coverage to get were cited by 15% and 12% of those who took the survey as reasons they have not purchased coverage.
Thankfully, Universal Life may provide solutions to some of those stated issues. Universal Life provides flexibility to change the value, death benefit, and premiums to fit your current needs and lifestyle. As a result, Universal Life continues to increase in popularity, with 34% of life insurance premiums being for Universal Coverage in 2022.
How Does Universal Life Insurance Work?
Universal life insurance offers financial protection by paying a death benefit to your beneficiaries when you die. However, this type of policy has several unique features that set it apart from many other types of life insurance. By offering lifetime coverage, a cash value, and the ability to adjust both your premiums and your death benefit, UL policies offer a significant amount of flexibility.
Here’s a closer look at some of the key features that set a UL policy apart from other types of permanent life insurance.
- Flexible premiums: The premiums for a UL policy are made up of 2 parts: the Cost of Insurance (COI) and the cash value. The COI represents the minimum premium needed to keep the policy in force. Premiums above the COI are added to the policy’s cash value. As long as there is enough cash value to cover the COI, you can decrease or even skip your payments without lapsing the policy.
- Cash value growth at market rates: The cash value component of a universal life policy typically earns the greater of the policy’s minimum interest rate or the current market rate.
- Flexible death benefit payout for beneficiaries: UL policies allow you to lower the death benefit, which in turn lowers policy premiums. You may also be able to raise your death benefit, although this may require a medical exam.
- Lifetime coverage: UL policies remain in force for the insured’s lifetime as long as you continue making your premium payments or there’s enough cash value in your policy to cover the minimum required premium payments.
Like many types of life insurance, eligibility for a universal life policy can vary depending on the insurance carrier. However, many UL policies require medical underwriting. This is used to determine whether an applicant qualifies for coverage. During the underwriting process, the insured is also assigned a rate classification, which influences the cost of coverage.
Medical Underwriting Requirements
Many insurance carriers require applicants to complete both a medical questionnaire and a medical exam. The carrier may ask questions about your lifestyle and hobbies, your family medical history, current medical conditions, and the prescription medications you’re currently taking.
The physical exam typically involves checking your height, weight, and vital signs, such as your blood pressure and pulse rate. You may also be required to submit blood and urine samples. In addition, the carrier typically requests access to your medical history, credit history, and driving record.
Types of Universal Life Insurance
There are two primary types of universal life insurance policies: indexed and variable. The difference lies in how the cash value is invested. This impacts the cash value’s potential growth and the overall market risk. Here’s a closer look at how each policy type works.
Indexed Universal Life Insurance
An indexed universal life insurance policy (IUL) allows policy owners to choose from a selection of market indices, such as the S&P 500 or the Nasdaq-100. The policy’s cash value then grows or declines each year based on the performance of the index.
It’s common for IUL policies to offer some type of cash value protection, which limits your losses. In some cases, they may have a floor that prevents the cash value from going down more than the set percentage, even during times of poor market performance.
The policy may also cap your gains. For example, a policy may have an 8% cap and a 0% floor. In this case, if the index is up 13% for the year, you receive 8%, and the insurance carrier keeps the difference. If the index is down 13%, instead of a 13% loss, you would see a 0% change.
Variable Universal Life Insurance
Variable universal life insurance (VUL) allows the policy owner to invest the cash value directly into various subaccounts: stocks, bonds, exchange-traded funds (ETFs), mutual funds, and money market securities. Many also have a guaranteed fixed-interest option. This can allow for more significant upside potential but may also create more market risk.
While VUL policies vary, some have a floor and a cap. The floor can prevent you from losing more than a set percentage of your cash value, while the cap limits your upside return. It’s common for VUL policies to have higher caps when compared to IUL policies. Some VUL policies do not have caps and therefore do not limit the cash value’s upside potential.
Universal Life Insurance vs. Other Life Insurance Types
There are many different types of life insurance policies to choose from. Some common options include whole life, term life, universal life, and variable life. Each type of policy has its own pros and cons. Understanding the differences may help you decide which option suits your needs.
5, 10, 20, or 30 years
$2,000 to $25,000
Up to $1 Million
Up to $1 Million
Cash Value Growth
Interest Growth on Cash Value
Reflects market rates
Based on market performance
Medical Underwriting Requirements
Medical examination typically required
Medical examination typically required
Medical examination typically required
Medical examination typically required
Universal Life Insurance vs. Term Life Insurance
While universal life insurance offers permanent coverage, term insurance covers an insured individual for a set period, such as 10 or 20 years. Once the coverage term ends, the policy owner can renew it, convert it to a permanent policy, or let it lapse.
While Term insurance does not have a cash value component, it also usually has lower monthly premiums. It’s typically used as a low-cost way to purchase life insurance without additional built-in savings.
Which Should You Pick: Universal or Term Life Insurance?
Since term policies don’t have a cash value, the premiums tend to be much lower. This allows policy owners to purchase larger death benefits at a budget-friendly rate. Term policies are popular among younger individuals who want to protect their families while their children are young or secure additional coverage until their mortgages and other debt is paid off. If you don’t need permanent insurance, you’re on a tight budget, or you need a large death benefit, a term policy may be attractive.
Universal Life Insurance vs. Whole Life Insurance
Universal life and whole life insurance are similar, but there are key differences. While UL policies allow you to adjust your premiums and death benefit, when you purchase a whole life policy, both the death benefit and the premiums are fixed.
Both policies also have a cash value. However, while the cash value in UL policies can fluctuate, whole life offers a guaranteed cash value. Instead of allowing the policy owner to invest the cash value in an index or subaccounts, a whole life policy typically pays a fixed interest rate on the policy’s cash value.
Which Should You Pick: Universal or Whole Life Insurance?
Universal life insurance offers significant flexibility but also comes with additional risk. Whole life insurance may appeal to individuals who want a guaranteed death benefit and a guaranteed return on their cash value. As long as you pay your premiums, you don’t have to worry about your whole life policy lapsing or your death benefit decreasing.
Universal Life Insurance vs. Guaranteed-Issue Life Insurance
Guaranteed-issue life insurance is a special type of insurance policy that does not require a health questionnaire or medical underwriting. It’s a form of permanent insurance, and some policies have a built-in cash value. However, these policies typically have a maximum death benefit of $50,000 and a 2 to 3 year waiting period.
If the covered individual dies from anything other than an accident during the waiting period, the policy does not pay out the death benefit. Instead, it provides the beneficiary with a return of premium plus interest. Universal life insurance typically requires full medical underwriting and has no other limitations.
Which Should You Pick: Universal or Guaranteed-Issue Life Insurance?
Guaranteed-issue life insurance policies may be attractive to individuals who have medical conditions that make purchasing other types of life insurance policies cost-prohibitive or impossible. However, due to the lower death benefit and waiting period, these policies may not be appropriate for individuals who can qualify for other types of life insurance.
If you’re looking for a permanent policy with cash value and do not have a disqualifying medical condition, you may consider a UL policy instead.
Universal Life Insurance vs. Variable Life Insurance
Variable life insurance is another type of permanent life insurance coverage. Like variable universal life, it also allows you to invest the cash value directly into market securities using subaccounts similar to mutual funds. One main difference is that a variable life policy has a fixed death benefit, while a VUL offers a flexible death benefit and adjustable premiums.
It’s also important to note that not every universal life policy is variable. Some are indexed, meaning that the returns are based on the performance of a market index rather than the performance of underlying subaccounts.
Which Should You Pick: Universal or Variable Life Insurance?
While both variable universal life insurance and variable life insurance policies allow you to choose how your cash value is invested, variable life may be less risky since it has a guaranteed death benefit.
Policy owners willing to commit to a fixed premium and want the security of knowing they have a guaranteed death benefit may prefer a variable life policy. Those who want more flexibility and are willing to monitor their policy values may prefer a variable universal life insurance policy.
How Much Does Universal Life Insurance Cost?
As with other types of life insurance, the cost of a universal life insurance policy varies depending on various factors, including the insured’s age, gender, and health, as well as their location and the insurance carrier.
Generally, there are several different costs to consider. The policy premium consists of two components, the cost of insurance (COI) amount and the savings component (cash value). The COI is the cost you pay for your death benefit and the insurance company’s administrative fees. This is the minimum premium required to keep the policy active. The amount of premium paid over the COI is added to the universal life policy’s cash value.
Since the COI is based mainly on the policyholder’s age, it typically increases over time. The amount applied to the policy’s cash value may decrease if you do not increase your premium payments. If the COI exceeds the amount you pay, the difference is withdrawn from the policy’s cash value.
The cash value investment portion of your UL policy may also have additional fees. For example, variable universal life policies typically have fees built into their investment subaccounts. These are similar to mutual fund expense ratios.
Advantages and Drawbacks of Universal Life Insurance
Before purchasing a universal life insurance policy, it’s important to understand the potential pros and cons. This can help you decide whether this type of policy may be appropriate for your needs.
Some of the potential advantages include the following:
- Lifelong coverage: Universal life is a type of permanent life insurance. As long as you make the minimum premium payments or there is enough cash value to cover the cost, your policy remains in force until you die.
- Flexible premiums: You can choose to lower or even skip premium payments as long as your policy has enough cash value to cover the cost of insurance. You can also make larger premium payments to increase your cash value, creating additional flexibility.
- Adjustable death benefit: You can lower your death benefit, which also lowers your premium. Some policies also allow you to increase your death benefit, although you may need to undergo medical underwriting before the carrier approves this change.
- Potential cash value growth: Depending on the type of policy you choose, you can either invest your cash value into an index or subaccounts, giving you the potential to grow your cash value based on market performance.
- Tax deferral: No taxes are due on the growth of the policy’s cash value unless it is withdrawn.
- Access to cash value: You can access the cash value in the policy during your lifetime, either through a withdrawal or a policy loan.
While the benefits of a universal life insurance policy may seem attractive, there are some potential drawbacks to consider. These include:
- Risk of lapsing your policy: If your policy’s cash value falls to $0 and your premiums don’t cover the cost of insurance (COI), your policy may lapse.
- No guaranteed return: The cash value in a UL policy can fluctuate based on the performance of the index or investments you’ve selected. In times of poor market performance, your cash value may decrease.
- Withdrawals may be taxable: Generally, withdrawals in excess of the total amount of premiums paid are taxed as ordinary income in the year in which they are withdrawn.
- Cash value may not be paid out after your death: When the insured dies, the insurance carrier generally pays the death benefit face amount and keeps the remaining cash value. Some policies are structured to increase the death benefit as cash value accumulates, but this can vary depending on the policy you’ve purchased, and structuring your policy this way typically results in higher premiums.
Should You Consider Universal Life Insurance?
Once you understand the potential advantages and drawbacks, you may still wonder whether a universal life insurance policy could meet your needs. While the answer to this question depends on your unique circumstances, there are a few situations when universal life insurance may be an appropriate choice.
Consider Universal Life Insurance If…
- You want permanent life insurance coverage with the flexibility to adjust your premiums and death benefit.
- You don’t have health conditions prohibiting you from being approved for a life insurance policy with medical underwriting.
- You’re looking for life insurance coverage with an investment component.
- You want to access your policy’s cash value during your lifetime.
- You can monitor your cash value and increase your premium payments if needed to avoid lapsing your policy.
Consider a Different Type of Life Insurance If…
- You have a disqualifying medical condition that makes it impossible or unaffordable to purchase a UL policy.
- You don’t want to worry about monitoring your policy values and avoiding a potential lapse.
- You don’t mind paying fixed premiums throughout the lifetime of the policy.
- You want a guaranteed return on your policy’s cash value.
- You want a guaranteed death benefit.
Putting It All Together
A universal life insurance policy may be a good option for individuals who want permanent life insurance with additional flexibility. If you think you may want to adjust your death benefit in the future or want the option to adjust your premiums, a UL policy allows you to make these changes.
The built-in savings component and ability to choose investments may also help you grow your cash value faster than other types of policies, potentially creating even more flexibility. If you’re still unsure whether a UL policy might be right for you, consider consulting with an insurance specialist or a financial professional who can help you evaluate the pros and cons and decide whether this type of policy may fit your needs.