Universal Life Insurance
Universal Life Insurance Explained: What You Need to Know
Universal life insurance is a form of permanent life insurance, which means it’s active until death. What sets this type of life insurance apart from other permanent life insurance is its flexibility. With universal life insurance, you can change the death benefit, your premiums, and other parts of the policy as needed. Like other forms of permanent life insurance, universal life insurance also includes a cash value component, which you can use for investments and loans.
This insurance type is ideal if you want long-term coverage but worry about being able to keep up with life-long payments. With this insurance, even if circumstances change, you can ensure your loved ones and beneficiaries are protected in case something happens to you.
In this guide, we’ll unpack everything you need to know about universal life insurance, including its main features and benefits, how it compares to other life insurance policies, and how to choose the best one.
What Are The Main Features Of Universal Life Insurance?
Universal life insurance includes a death benefit (the sum paid out to beneficiaries), a cash value component, and flexible premiums. These features are explored below:
Flexible premiums
The most appealing feature of universal life insurance is its flexibility. This means you can choose to change your premiums (monthly payments) or change the death benefit. This is unique, as most life insurance policies have a level premium where you pay the same premium for the life of the policy.
Why would you want to adjust your policy? There are several reasons:
- Increased savings: You can choose to pay more than needed so the cash value of your policy accumulates faster. You can then use this for investments or as some spare cash during your lifetime.
- Life changes: Life changes, such as having more children or taking on debt, may lead to you needing a higher death benefit. This ensures your beneficiaries have enough funds if you pass away unexpectedly.
- Financial hardship: You can choose to reduce your premium payments to the absolute minimum if you lose your job or run into a massive expense. This ensures you are still covered and takes away the stress of high monthly payments until you can get back on your feet.
The bare minimum premiums you can pay are determined by something called the Cost of Insurance (COI). This is the total cost of keeping your policy active, including mortality and administration fees. This cost varies from person to person, depending on their age, lifestyle choices, risks, and death benefit amount.
Cash Value Accumulation
A part of your monthly premium goes towards a cash value. This earns interest, which can change based on policy limits or the market. The good news is that this growth is completely tax-deferred, and you won’t have to pay taxes on any extra value your cash earns over time.
There are several uses of the cash value your policy earns, including the following:
- Investment: You can invest the accumulated cash value in securities to earn higher interest on it.
- Savings: You can use the cash value as extra cash, borrow against its value, or make a withdrawal.
- Policy loans: You can borrow against the cash value of your policy without tax implications.
- An extra death benefit: In some cases, you can stipulate that the remaining cash value goes to your beneficiaries after you die. Keep in mind that this may result in a more expensive monthly premium.
The cash value from a universal life insurance account accumulates slowly. It may take as long as 10-15 years to build up a substantial amount. On the other hand, it is a relatively easy way to put aside money without thinking each month. The main downside of a life insurance cash value account is that it rarely has competitive interest rates. However, it’s better to have it than not have it. Not to mention, the cash value is an automatic part of a permanent life insurance policy, and it’s hard to find permanent policies that exclude this feature.
Coverage Duration
Universal life insurance is designed to last a lifetime. The policy remains active as long as premiums are paid, and it does not expire like term insurance.
How Does Universal Life Insurance Compare With Other Life Insurance?
Universal life insurance is a type of permanent life insurance. You can also get a termporary form of life insurance, known as term life insurance. Universal life insurance covers you up until death, while term life insurance covers you for a set term. Term life insurance does not accumulate cash value. The table below summarizes the main differences between types of permanent life insurance as well as term life insurance:
| Features | Universal life insurance | Variable life insurance | Whole life insurance | Term life insurance |
|---|---|---|---|---|
| Duration | Lifetime | Lifetime | Lifetime | 10-30 years |
| Premium Stability | Changeable | Stable | Stable | Stable |
| Management intensity | High. Needs investment management (if you want), and management to adjust your policy. | High. The investment component needs a lot of management. | Medium. The cash value still needs to be managed. | Low. Only the death benefit is included. |
| Cost Comparison | Depends on your policy adjustments. Still more expensive than term life insurance. | More costly than term life insurance. | Most expensive. Both death benefit and cash value growth are guaranteed. | Cheapest option. |
| Tax-deferred cash value growth | Yes | Yes | Yes | No. There is no cash value component. |
| Death benefits | Yes | Yes | Yes | Yes |
| Target demographic | Young individuals with good income. | Individuals with an interest in investment | Individuals who have maxed out their 401(k) and retirement accounts. | Anyone who needs life cover for a temporary period. |
Overall, the permanent life insurance options only have minor differences between them, and term life insurance is in a whole other category for cost and extra benefits. In terms of premium payments, universal life insurance gives you the most customization options.
Investment Options in Universal Life Insurance
Investing your policy’s cash value is a great way to earn a little more on top of your saved amount. Popular investment accounts include:
- Fixed-rate investment accounts: This account allows you to earn fixed interest on your cash value. The interest is determined by the insurance company, which means it may be low, but you won’t have to worry about market volatility.
- Indexed Universal Life Insurance (UIL): An IUL policy links your cash value growth to an index such as the S&P 500. This can result in less predictable gains but more overall growth than a fixed-rate account.
- Variable Universal life insurance (VUL): This account combines the benefits of Universal and Variable life insurance. You can invest in a wider variety of securities, such as mutual funds, stocks, and bonds. You have the potential for higher growth but at higher risk.
The Risks And Downsides Of Universal Life Insurance
By now, you know the benefits of universal life insurance, including flexibility, savings and investment options. However, this type of insurance has a few downsides as well:
- Market dependency: Some cash value accounts are tied to market rates, which means your funds may not grow as much as you’d like. However, most policies have a minimum interest rate, so you won’t actively lose money.
- Underfunding risks: If you choose to lower your monthly premiums, you may underfund the policy over time. This can result in a lower death benefit payout or less cash value growth.
- Lapse potential: If you take out a loan against the value of your accumulated funds or your cash value depletes to zero, your policy may lapse, terminating the coverage.
- Loan Repayment Failures: Unrepaid loans reduce the death benefit and may incur taxes if the policy is terminated or if the policyholder passes away.
- Non-transferrable value: Most cash values do not go to your beneficiaries unless you find a policy that allows this. This means you need to use your cash value or lose out on value.
- Impact of Withdrawals and Loans: Taking out loans or making withdrawals can lower the death benefit, potentially affecting the financial security of beneficiaries.
Luckily, a well-managed account should have none of these issues. However, be careful when making policy adjustments to ensure that you don’t end up in a position where your policy may lapse due to underfunding.
How to Choose the Right Universal Life Insurance Policy
When it comes to choosing a universal life insurance policy, there’s a lot of variety out there. Some policies have a bigger investment focus while others have more rigid rules regarding policy adjustments. To help you choose a good universal life insurance policy, consider the following steps:
- Assess coverage: You need to consider how much coverage you need, and then find a policy that offers this level of coverage. When choosing coverage, take into account income replacement, outstanding debts, future financial responsibilities like children’s education, and your current financial assets.
- Compare insurance providers: Shop around and find a few quotes before deciding on a final insurer. Look specifically for companies with financial stability and a good reputation with clients. Also consider if you can add anything extra to your policy, such as policy riders.
- Payment structure: See what sort of payment structure works for you. You can choose between single premiums, limited pay or level pay.
- Payment frequency: With universal life insurance, you might be able to choose a flexible payment frequency – monthly, quarterly or annually. Choose the option that works best with your budgeting and planning style.
Ultimately, you should try to find a policy that works with your budget and offers what you’re looking for in a life insurance plan. Remember, the goal of life insurance is ultimately to protect your beneficiaries if anything happens to you. So choose carefully. Good luck!
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