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LIFE Insurance
LIFE INSURANCE INSIGHTS

Universal life insurance offers permanent coverage that allows you to make changes to premiums and death benefits.

Universal life insurance

Most people who buy life insurance look at one of two options: term life or whole life, but there's another option – universal life insurance.

Universal life insurance policy is a type of permanent life insurance policy that offers more flexibility than whole life coverage.

You typically can increase or decrease your death benefit amount and change how you pay premiums over time. In addition, many universal life insurance policies allow you to build cash value.

Read on to learn more and discover the pros and cons of universal life insurance.

KEY TAKEAWAYS
  • Universal life gives policyholders the option of changing premiums and death benefits.
  • The option to change the death benefit and premiums can be a huge benefit to customers if their financial circumstances change. 
  • Universal life policies have a cash value component, which is similar to whole life.
  • Cash value lets you tap into the money while you're alive.

What is universal life insurance?

A universal life insurance definition is a type of permanent coverage that offers flexibility. These policies allow you to change the terms of your policy, such as shifting how you pay premiums or increasing or reducing your death benefit.

Unlike a traditional whole life insurance policy, a universal life policy gives you more options for how you pay premiums and allows you to adjust the death benefit over time. In addition, many universal life policies let you build up savings – known as “cash value” – that earns interest tax-deferred. You have the option of loans or withdrawals from the cash value of the policy, but you'll need to pay back the policy loans or your beneficiaries may receive a lower death benefit.

Universal life insurance policies are a variation on whole life insurance. They originated in the 1970s and 1980s.

How does universal life insurance work?

Each time that you pay the premium on your universal life insurance policy, part of the money goes toward the death benefit and another part goes into the policy's cash value. 

The money in the cash value portion of your policy earns interest. Depending on the type of universal life insurance, the interest in your cash value can grow at modest rates, such as those in a money market account, or at more aggressive rates, such as those tied to the stock market. The interest you earn for your cash value is income tax-deferred.

Eventually, this money builds to the point in which you can begin withdrawing or borrowing against it if you want. Each life insurance company has its own rules about when you can dip into this amount.

Another aspect of universal life insurance that differs it from other policy types is flexible premiums.

“Customers can choose to pay level premiums every year, but they also can choose to overfund their policies in early years or even pay with just a single large premium,” says Joe Kenny, vice president and actuary, life product performance, at Mutual of Omaha.

While it can make sense to tap into a policy’s cash value, there’s a downside:

  • Taking money can lower your death benefit and you may owe taxes on the distribution. And if you withdraw too much or use up your cash value to pay premiums to universal life insurance companies, it’s possible your policy could lapse.

A universal life policy also allows you to increase or reduce the amount of your death benefit.

If you reduce the death benefit, the cost of your policy likely will fall. If you want to increase the death benefit, you probably will need to pass a medical exam and your premium will likely increase.

“The death benefit can be decreased or increased without needing to issue a different policy,” Kenny says.

However, he notes that increases in the death benefit will typically require new underwriting, so you may need a medical exam and answer health-related questions.

What is included in a universal life insurance policy?

Universal life insurance guarantees a death benefit when you die as long as you stay current on premiums.

Universal life policies also have cash value, similar to other permanent life insurance policies. You can take money from a policy’s cash value while you’re still alive. You need to pay back the money taken out of cash value or your beneficiaries will receive a smaller death benefit when you die.

Universal life insurance also lets policy owners choose the premiums each year. You may want larger premiums to put more money into their policies or decrease premiums if needed.

You can also increase or decrease the death benefit. However, if you want to increase the policy’s death benefit, you may need a new medical exam before the life insurance company allows it.

Who should buy universal life insurance?

Universal life insurance makes sense for policyholders who want to provide financial protection for their loved ones but who also want more flexibility in the terms of their policy.

“It appeals to customers who are interested in the potential growth of tax-deferred savings through the policy’s cash value, which provides future flexibility,” Kenny says.

For example, with universal life insurance, your cash value grows that you can tap into for things like emergency expenses or your child’s college tuition.

This type of coverage also makes sense for those who want the ability to change the amount of their premium payment or to adjust the amount of their death benefit.

What are the different types of universal life insurance?

There are several different types of universal life insurance policies. They include:

  • Guaranteed universal life insurance
  • Indexed universal life insurance
  • Variable universal life insurance

The best universal life insurance policy is the one that meets your own individual needs. Read on to find out more about the pros and cons of the various types of universal life insurance.

Guaranteed universal life insurance

Guaranteed universal life insurance is sometimes described as occupying a middle ground between term life insurance and whole life insurance.

Like a whole life policy, it stays in effect until you die as long as you pay the premiums. But a guaranteed universal life insurance policy -- which is designed with affordability in mind and often charges lower premiums – typically has little or no cash value, similar to term life.

The “guaranteed” aspect of this policy comes from the fact that your premium is guaranteed not to increase during the life of the policy. The policy itself won’t lapse as long as you pay the premiums.

Pros and cons of guaranteed universal life insurance: Guaranteed universal life insurance typically costs more than a term life policy but less than a whole life policy. These policies can be a good fit for folks who want lifelong coverage at an affordable rate.

However, those who want a cash-value component in their life insurance probably should look at other options.

Indexed universal life insurance

With indexed universal life insurance policies, the interest paid out to you is tied to an index of investments, such as the Standard & Poor’s 500 stock index or an index of bonds.

Universal indexed life insurance products also typically have an interest-rate guarantee. This means you earn a minimum guaranteed interest rate even if the index tied to your policy gets lower returns. However, interest rates typically are subject to an upper limit cap.

Pros and cons of indexed universal life insurance: The biggest upside to an indexed universal life insurance policy is that you can earn larger returns if the index your policy is tied to – such as the S&P 500 – does well.

However, critics charge that these products often come with expensive fees and warn that investment returns may be capped in ways that limit how much benefit you will reap from them.

Variable universal life insurance

A variable universal life policy features a blend of features characteristic of variable life and universal life policies. You can adjust the insurance premiums and you have the option of investing the cash value in financial markets.

In fact, one of the biggest differences between variable universal life and standard universal life insurance policies is that you have more investment options with the former. You can also withdraw money from the cash value to pay expenses as they arise.

Like most policies on this list, you can increase or decrease the death benefit as your life circumstances change.

Pros and cons of variable universal life insurance: The pros and cons of variable life insurance are similar to those of indexed universal life insurance. While these policies have a higher upside compared to other forms of life insurance, you need to pay close attention to market performance and make adjustments as necessary to meet your goals.

What makes universal life insurance different from other life insurance policies?

One quality truly separates universal life insurance from other life insurance policies is flexibility.

With this type of policy, you can:

  • Increase or decrease the death benefit
  • Flexible premium payments if you have enough money in cash value

The cash value options with these policies often allow you to select from a range of investment choices.

If your life circumstances change -- particularly in terms of your finances -- a universal life policy offers the flexibility to change your policy to better meet your needs.

Pros and cons of universal life insurance

Universal life insurance can be a great option for those who want more flexibility in their policy terms. The ability to change your death benefit and alter how you pay premiums can be a huge benefit to customers if their financial circumstances change.

What are some disadvantages of universal life insurance? You may take on more risk with these policies. For example, if your cash value is tied to the financial markets, it is possible the amount of money in your policy could increase and decrease as markets fluctuate.

In addition, unlike with whole life insurance, your premium amounts sometimes can increase over time, particularly if the investments tied to your account perform poorly.

Alternatives to universal life insurance

Universal life insurance isn’t your only option. The two other big alternatives are term life insurance and whole life insurance.

Term life insurance provides coverage for a specific period. When you purchase a term policy, you’re typically covered for between 10 and 30 years depending on the policy.

This type of coverage is affordable and can be purchased in large amounts. However, when a term life policy expires, the policy doesn’t gain cash value. The coverage also ceases at the end of the term.

Whole life insurance is a type of policy that remains in place for the insured’s lifetime as long as he or she pays premiums. Unlike term life insurance, a whole life insurance policy doesn’t expire after a specific period. A whole life insurance policy also includes a "cash value" component.

Whole life vs. universal life

Whole life and universal life insurance are similar in that they both are forms of permanent life insurance. Your benefits remain in place for your lifetime as long as you pay the premiums.

Both of these types of policies typically allow you to build cash value. If you cancel either type of policy, you receive the cash value minus fees.

However, there are some key differences when thinking about universal vs. whole life, and they mostly come down to flexibility:

  • Whole life has fixed premiums and death benefits.
  • Universal life allows policyholders to change premium and death benefits.
  • Whole life offers a steady interest rate for cash value.
  • Universal life’s interest rate for cash value can fluctuate.

Term life vs. universal life

There are significant differences between term life and universal life:

  • The cost of insurance is usually lower for term life.
  • Term life lasts for a specified period of time, usually 10 to 30 years.
  • Universal life insurance remains in place for your lifetime as long as you pay the premiums.
  • Term life doesn’t have cash value.
  • Universal life allows policyholders to build cash value, which they can use to tap into to pay premiums or for other reasons.

Frequently Asked Questions

What if I no longer want my guaranteed universal life policy?

If you no longer want your guaranteed universal life policy, you can simply stop paying your premiums. This will cause the policy coverage to lapse.

Does universal life insurance expire?

Universal life insurance doesn’t expire as long as you pay your premium and fulfill all other requirements of your policy.

However, it’s possible your policy could lapse if you run into hard economic times and decide to curtail or stop making premium payments while counting on the cash value in your account to cover your premium. This works fine until your cash value savings run out. At that point, you’re in danger of the policy lapsing.

To prevent this situation from occurring, make sure you talk to your agent before you stop making premium payments. Your agent can guide you as to whether you have enough cash value to use this strategy and for how long you can successfully do so.

What happens to cash value in a universal life policy at death?

Most universal life policies have two options for the death benefit, Kenny says.

In the first option, the beneficiary receives the face amount of the policy upon death. In these instances, the cash value would remain with the insurer.

In the second option, the beneficiary gets the face amount, plus the cash value.

Kenny says the first option tends to be cheaper for the policyholder.

Should I cash out my universal life insurance policy?

Whether you should cash out your universal life insurance policy is a highly individual question. Remember that doing so means you no longer will have that life insurance coverage.

However, for some people in dire financial straits, this may be their best – or even their only – option for getting at cash fast.

The best way to determine if this is the right move for you is to run the numbers on your own. Seek the input of both your insurance agent and an independent financial adviser. Taken together, this combination of research and advice can help you determine if this is the right move for you.

How do you customize a universal life insurance policy and value?

You can ask the life insurance company to change your premiums and death benefit.

Increasing your death benefit may mean the life insurance company will want a new medical exam to gauge your health before agreeing to increase the policy’s value.

This customization aspect to universal life makes it different from whole life insurance, which doesn’t provide that option.

Do you need to have a medical exam for universal life insurance?

Yes, similar to other life insurance policies, life insurance companies usually want prospective policy owners to go through a medical exam.

The medical exam allows the insurance company to gauge risk. If the life insurer is concerned about your health, it may decline to cover you.

How do you take money from cash value?

You can contact the life insurance company if you want to tap into the cash value portion of your policy.

There are three options: Take out a loan, withdraw funds or surrender your policy. Here are the differences.

Taking out a loan on the policy’s cash value means you have to pay back the amount plus interest or it will be subtracted from the policy’s death benefit.

Withdrawing funds lowers the death benefit.

Surrendering or canceling the policy allows you to get the cash value after the life insurer subtracts any penalties, unpaid balance and outstanding loans. However, it also means you longer have that life insurance policy.

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