Universal life insurance
More than half of Americans own life insurance, with 54% having some coverage, according to LIRMA’s 2020 study. Life insurance is an important resource as you build out a long-term financial strategy for you and your family. It provides your family with a monetary death benefit in the event you pass away, which can cover end-of-life expenses or help your beneficiary’s financial future.
There are different types of life insurance policies providing coverage for temporary or permanent needs. Universal life insurance is a permanent policy with flexible benefits and premiums, allowing changes as your lifestyle or finances change.
What is universal life insurance?
With a universal life insurance policy, you make premium payments in exchange for a set death benefit. As you pay your premium over time, part of the money goes into an account that accumulates a cash value while earning interest.
In other words, a universal life insurance policy also acts as a savings account. As the cash value grows, you can opt for a lower premium payment using the savings to make up the difference.
What are the pros and cons of universal life insurance?
- Builds cash value: Like whole life insurance, universal life insurance has a cash value component that grows with the policy. You can borrow against the cash value, use it to pay premiums or surrender the policy for the cash value if you no longer have the need for permanent life insurance. Borrowing against the cash value does not require a credit check and is tax free. If you do not pay back the loan, the death benefit will be reduced by the outstanding loan balance.
- More flexibility than whole life insurance: Universal life insurance offers the ability to increase or decrease the death benefit and adjust premiums if needed. This flexibility is not found in whole life insurance, which is one thing that sets universal life insurance apart. If a life event happens, like having a baby, you can increase your death benefit — though you will have to pay the increased cost.
- Investment strategy options: There is more than one type of universal life insurance, including indexed and guaranteed. Indexed universal life insurance offers stock index returns which offer growth potential you can cash out later if needed. Guaranteed universal life insurance offers a fixed option guaranteed to provide the death benefit until a specified age determined by the life insurance company.
- Monitoring is required: Unless you choose guaranteed universal life insurance, it is not a policy you should set up and forget about. If the policy is not funded properly with at least the target premium, it could lapse. If using the cash value to pay premiums, make sure the value does not diminish to the point where the policy is in danger of lapsing.
- Building cash value takes time: It can take time to build enough cash value in a universal life insurance policy to make it usable, especially if you pay the minimum target premium. Paying more than the minimum can help the cash value grow faster. Not all universal life insurance policies are created equal. Some policies have a guaranteed growth potential while others do not, which may help you decide which policy type and carrier to choose.
- An increase may require a health exam: While flexibility in raising the death benefit amount is a nice benefit, some carriers require a medical exam for the increased amount. The cost of the increased death benefit is subject to health exam results, which may be more than you thought if you are not in great health. If this is a reason for choosing universal life insurance, ask your insurance agent about the carrier’s requirements about increasing coverage.
How does universal life insurance work?
Universal life is structured to have two distinct components. Part of your premium payment goes to the insurer, contributing to your death benefit and administrative costs. Another part goes into a savings vehicle that earns some type of interest. You have a few options of what to do with that money as time goes on.
Cover your premiums
One option is to use the money to cover your premium payments, rather than paying out-of-pocket. Some people appreciate this flexibility in case they hit a financial roadblock down the road.
Borrow from the savings account
You can also withdraw or borrow money from the savings account. Each insurance company has rules about how much you can borrow and what happens to your death benefit (in some cases, it may be reduced). Also, check to see if you’ll owe any taxes before dipping into your universal life policy.
Be careful that you don’t drain your account completely, which could cause your policy to lapse — meaning your beneficiaries wouldn’t receive a death benefit even if you’ve held a universal life insurance policy for years.
Types of universal life insurance
While the overall concept of universal life insurance is much more flexible compared to a term life policy, there are a few different types you can choose from depending on your goals and financial situation.
Indexed universal life policies
An indexed universal life policy is tied to a market index. That means the savings portion of your account will fluctuate based on the performance of the stock market. Your insurance company will also likely take off an additional administrative fee for managing your account.
Obviously, this is a riskier option because you don’t have a fixed interest rate and your account value can drop.
Guaranteed universal life policies
This is a low-risk option with a fixed premium for your entire life. Your account won’t grow significantly in terms of cash value, but you’ll have a consistent premium that doesn’t change based on the stock market.
It’s not a growth-oriented type of universal life insurance policy, but it’s also not a volatile one.
Variable universal life policies
Variable universal life is similar to an indexed policy, except that you can diversify your investments through money market accounts. There’s still a level of risk because there’s no way to predict how the stock market will perform, even with your funds diversified.
Like an indexed universal life policy, you’ll be charged administrative fees with this one as well.
Is universal life insurance worth it?
One of the benefits of getting a universal life insurance policy is that your death benefit remains valid as long as you keep up with your premiums. This is different from term life insurance, which only lasts between five and 30 years, depending on your policy. If you want a policy that sticks with you as you get older, universal life is a good option.
You may also be attracted to the cash value component of universal life insurance. But it’s always smart to talk to a financial advisor and compare all savings vehicles before making a decision.
Frequently asked questions
What are the disadvantages of universal life insurance?
Universal life insurance typically comes with higher premium payments compared to a term life option. Also, you’ll likely have to pay administrative fees for the cash value component. The cash in your savings vehicle can fluctuate, particularly if it’s tied to an index or mutual fund. That can cause your premium to increase, putting a greater financial strain on your wallet.
What is the difference between whole and universal life insurance?
Both are types of permanent life insurance, so your policy doesn’t expire because you hit a certain age. The main difference is how the cash value portion of the account is handled. With whole life insurance, your premium is fixed. With universal, your premium can change if you opt to pay for it with your accumulated cash value.
Because the value of your cash savings can change, your premium payment can jump up if your cash value goes down or you borrow money from it.
Why should you buy universal life insurance?
Universal life insurance may be a good choice if you want that permanent coverage. Term life, for example, is ideal if you only want the death benefit for a certain period of your life, such as when your kids or young or you have a large mortgage.
If you want your beneficiaries to receive a death benefit even if you pass at an old age, universal life could be a more affordable option to get that coverage without it ever expiring.
Should you cash out your universal life insurance policy?
It’s typically best to only cash out your universal life insurance policy if you’re in the midst of a major financial emergency. If you do, make sure you understand any tax implications, especially if your contributions were made in a tax-advantaged account. In some cases, any withdrawals may result in higher tax payment.
Also, find out what happens to your death benefit. Oftentimes, your death benefit is reduced if you take money out of your savings vehicle.