Learn more about universal life insurance and whether it is right for you.
What Is Universal Life Insurance?
Universal life is a form of “permanent” life insurance. It is made to cover you for your entire life and payout a set amount of money upon your death. It also has a cash value that you can access as a loan while you’re living. UL differs from other types of permanent life insurance. The main difference is that it doesn’t have set premiums. You can pay any amount you want within the minimum and maximum premium (payments) stated in the policy. These payments are based on your age, gender, medical history, and the amount of coverage you choose.
Alternate name: Adjustable life insurance
How Universal Life Insurance Works
All permanent life insurance policies have three parts: the premium, the cash value, and thedeath benefit. You can choose from two schedules; there are also some fees and penalties you should be aware of.
Premium
The money you pay into the policy first covers the company’s cost to protect you and administer the plan. If you pay above the minimum payment, any excess goes into the cash value. If you don’t pay more than the minimum, funds are taken from the cash value to make the payment.
Cash Value
The cash value (or account value) is a portion that you can access. The insurance agency places some of your money into investments that make the cash value grow. Or, you can choose the investments that make up the cash value if you prefer certain ones (if you’ve chosen a variable universal life policy). Cash value interest and gains are not taxed unless they are withdrawn or surrendered.
Death Benefit
Payments to beneficiaries when you die are called the death benefit (also called the face value). Universal life has two basic death benefit options. Option A is a level death benefit, called the specified or face amount. Option B is the face amount plus the cash value. In Option A, more of your payment goes toward building the cash value; in Option B, more goes toward raising the death benefit through investing. Many companies offer extra death benefit options in the form of riders.
Schedules
Universal life policies have two different “schedules” used to figure out how much you’ll pay. Your payment is based on policy charges and maintenance costs. These charges are what you’re paying for. They can be found on your quarterly insurance statement. The “current schedule” is based on the cost of the insurance company’s claims, investment results, and expenses. The “guaranteed schedule” shows the maximum amount you can be charged. The insurance company can raise or lower the current schedule, but not more than the guaranteed maximum stated in the policy. With a UL policy, you can adjust your payments up or down. A higher payment will increase the cash value, while a lower or no payment may decrease it. The total value of the cash value depends on how much interest is credited to it. This works well if you need to lower your payments due to your current finances. You can also choose to increase your payments to capitalize on the tax-deferred growth in the cash value. Other types of permanent insurance, like whole life, have a fixed payment schedule that can’t be changed.
Surrender Period and Charges
Most universal life policies charge a penalty if you cancel it. You’ll also be charged for taking out more than a certain amount of the cash value within a set period. A surrender period is a time frame in which you can cancel the policy and take the cash value; however, you’ll be penalized with charges if you do. The period length can be chosen by the insurer and can range up to 15 years. The surrender charges and how they are figured are stated in the policy. Make sure you read over your policy if you’re thinking about canceling it before the surrender period is over. Once the surrender period ends, you’re able to cancel the policy and take the cash value without being charged for it. You may still need to pay taxes on the amount you receive. How much you pay in taxes depends on how long you have paid into the policy. The amount also depends on how much you are paid and whether it is taxed as income or capital gains. You may want to talk to a tax professional if you’re thinking about surrendering your policy because the tax laws are complex.
Types of Universal Life Insurance
UL policies are available in three styles: fixed-rate, indexed, and variable.
Fixed-Rate
Your money is placed into the cash value component as part of a general portfolio. Any interest is credited to the account based on the returns of the investments in the portfolio. Though fixed-rate universal life policies have a minimum interest guarantee, they don’t create much growth when interest rates are low.
Indexed
Most new universal life policies are indexed universal life policies. Indexed policies offer you the potential for stock market gains without the risk of losing principal. The cash value component is credited based on how a financial index performs. This means that the investments in the cash value portion mirror a stock index like the S&P 500. If the index value goes up, the cash value is credited up to the policy’s cap (or ceiling). If the index goes down, there are no interest credits and no losses to the cash value.
Variable
You choose the mutual funds the cash component is invested in. The cash value will gain and lose value as the investments in the portfolio gain and lose value. If investments perform poorly, the cash value can decrease even if you’re making payments. If the losses are high enough, the policy could lapse because the cash value could be reduced to zero.
Pros and Cons of Universal Life Insurance
Term Insurance
Term insurance expires after several years. Many policies range from 10 to 30 years. Term insurance is pure insurance protection, which means it has no cash value and can be an inexpensive alternative. It is a good choice for young families who may need high amounts of protection for a short number of years. For an extra premium, you can buy term insurance with an option to convert it to permanent.
Whole Life Insurance
Whole life insurance is permanent and stays in force until the death of the insured. Whole life has a guaranteed fixed monthly payment and cash value. You can also get it with term insurance that supplements insurance protection. Whole life tends to be sold by mutual insurance companies that pay you dividends based on the company’s profits.
Is Universal Life Insurance Right for You?
If you need permanent life insurance, you should consider universal life. Premiums can be adjusted (or paused) if needed, and the cash value grows tax-deferred. You can sometimes access the cash value without paying taxes. Also, most universal life products let you choose from many living benefit riders that can help cover other costs. Some examples of these costs are long-term care expenses and supplemental retirement income. UL can also be a solid choice for younger adults who have or expect to need insurance. If you’re young and want to lock in low rates while you’re in good health, you’d benefit from the tax-deferred nature of the cash value account. If you’re a low risk to the company, you might find that the interest credited to your account covers the cost of insurance and policy charges (meaning you might be able to get UL to pay for itself). This example might be more likely with an indexed policy where interest credited is based on the returns of a stock market benchmark like the S&P 500, especially if interest rates are low.
