What Is Universal Life Insurance?

By | September 1, 2021
Universal Life Insurance

Universal life insurance, like whole life insurance, is a type of permanent life insurance policy that accumulates tax-deferred cash value. The policy stays in effect for as long as you remain alive and pay the premiums. In contrast, a term life policy is only effective for a given period of time – the term – and it does not accumulate cash value. 

The primary difference between whole and universal life – also called adjustable life – is that universal life is more flexible. For example, some universal life policies allow you to increase the death benefit or change your premium payment schedule. However, universal life is more expensive than term and more complicated than term or whole life. As a result, it isn’t for everyone. Is it a good option for you? Read on to find out.

What Is Universal Life Insurance?

According to the Insurance Information Institute, universal life insurance offers permanent coverage and provides options that whole life insurance doesn’t. For example, a universal life insurance plan may allow you to increase the death benefit without changing to a new policy. The death benefit is the amount your beneficiaries will receive if you die. You also may be able to lower your premium payments. The amount of money in the policy, otherwise known as the cash value, will determine if one or both of these options are available.

Differences between Term, Whole, and Universal Life Insurance

The California Department of Insurance and the Washington State Insurance Commissionerexplain that cash value accumulates if premium payments and the interest on those payments exceed the cost of insurance (COI). Likewise, if the COI exceeds your premium payments plus interest, the cash value in the policy decreases. The COI determines the minimum premium payment needed to maintain the policy. According to the New York State Department of Financial Services, the COI includes a share of the insurance company’s operating expenses such as agents’ salaries, legal expenses, rental fees, etc. The COI also depends in part on your mortality, or risk of death while the policy is in force, as well as how much insurance coverage you have. The COI increases as you age, resulting in higher premium payments – something to keep in mind when you retire and are living on a fixed income.

The cash value component of a universal life insurance policy earns interest, with the earning rate tied to the insurance company’s portfolio or a market index. These earnings increase the cash value, which can allow you to increase your death benefit or lower your premium payment amounts or frequency if the account has enough money in it to make up the difference. Increasing your death benefit can be a good option if your beneficiaries’ financial needs change. Lowering your premium payments or payment frequency can help if you find yourself in a difficult financial situation. 

Employing one of these options will start to use up the cash value in your policy. If you consume all of the cash value, the policy may lapse, leaving you without coverage. To prevent this, you’ll have to decrease your death benefit and/or raise your premiums before the policy lapses. It’s a good idea to talk first to your insurance agent, especially if you’re considering lowering your premium payments for an extended period of time. He or she will determine whether you have accrued enough cash value and can explain all of the ramifications.

Because the cash value of a universal life policy depends in part on a market interest rate, it’s impossible to predict how much it will grow or shrink over time. If you’re uncomfortable with this type of financial risk but still want a policy that accumulates cash value, consider a whole life policy. Its cash value grows based on a fixed interest rate that your insurance company sets annually.

How Does Universal Life Insurance Work?

Universal life is a permanent type of life insurance policy that typically has lower premiums than whole life, another type of permanent life insurance. Universal life policies accrue cash value over time, and most allow you to adjust your death benefits and premium payments. Some have a fixed premium or require a single upfront premium payment.

The cash value in a life insurance policy is similar to a savings account, earning a market interest rate. When you accrue enough cash value, you can access some of it without lowering the death benefit. Alternatively, you can use the excess cash value to skip one or more premium payments. 

Although the cash value in the policy grows tax-deferred, you will pay taxes on any money you withdraw. In addition, your beneficiaries won’t receive any of the cash value when you die; they only get the death benefit, and the insurance company keeps whatever excess money the policy contains. If you terminate the policy during your lifetime, you keep some or all of the cash value that has accrued.

You can also borrow against the cash value in a universal life policy. The loan isn’t taxable if you pay it back while the policy is still effective and doesn’t require an application or credit check. However, insurance companies often charge high administrative fees, the death benefit is reduced by the amount of any unpaid loans, and the policy’s cash value is often reduced by the amount of any unpaid interest. Moreover, the policy might lapse if the loan and interest together exceed the cash value.

Although there are some advantages to cash-value life insurance policies like universal life, there are disadvantages as well. David Paige, an insurance industry attorney and consultant based in New York City, says cash-value policies are “a forced-savings mechanism” that might not be best for everyone. For example, he notes that commissions paid to agents or brokers who sell cash-value policies can be more than 100% of the total premiums during the first year, which means a policyholder would build no cash value in the policy for that period of time. Moreover, investment funds created by insurance companies for investing premium payments are “fairly conservative” and don’t grow very fast, Paige says. “Plus, there are fees upon fees in many of these funds that aren’t always disclosed without being very good at reading the fine print.”

Paige says policies that allow people to select investment vehicles – particularly, but not exclusively, variable universal life policies (see below) – have been disfavored by some insurance regulators. “Many people who buy these policies aren’t very financially sophisticated, and growth projections sometimes are overly rosy and make assumptions that may not be fair,” he says. “It’s less a problem with the policies themselves than the way they are presented.” Paige emphasizes that this is not the case with all universal life policies, many of which are perfectly fine. But if you’re considering a universal life policy, be aware of these possible downsides.

Even though universal life insurance is considered “permanent,” it does have a maturity date. The maturity date corresponds to when you reach a certain age specified in the policy, usually 85 or higher. After this date, you’ll receive a payment and coverage will end. Although the payment is usually equivalent to the cash value of the policy, it could be the death benefit or some other amount. Select a maturity date carefully when you buy the policy so coverage lasts long enough to accomplish your financial goals.

Beneficiaries usually receive death benefits via a tax-free single payment. In some cases, they can choose to receive monthly or annual installments instead. An annuity might also be an option, which splits the benefit between regular installment payments and an investment account. If the benefit earns interest, beneficiaries might have to pay taxes on those earnings.

Variable universal life and indexed universal life are specialized types of universal life insurance. A variable universal life policy has the same features as a regular universal life policy with one important exception: instead of the insurance company investing the cash value, you choose how it’s invested. Investment options can include stocks, bonds, mutual funds, and other vehicles. You may invest the money in one account or multiple accounts. Variable universal life insurance is complicated, can involve high management fees, and carries significant investment risk. As a result, it probably isn’t the best choice for most people. But if you’re comfortable with the risk and are looking for a potentially higher rate of return than that offered by regular universal life, variable universal life might be worth considering.

Indexed universal life is a type of universal life policy in which the interest rate is tied to the performance of one or more index funds that you select. These could include the S&P 500, NASDAQ 100, or other popular indexes. You also might be able to earmark part of the cash value to earn in a fixed-rate account and assign the remainder to an index fund. The portion in the fixed-rate account will have a higher guaranteed interest rate and lower risk, but its potential rate of return will also be lower. Note that the portion of the cash value that’s tied to an index isn’t actually invested in that index. Rather, the amount of interest you earn is tied to the performance of that index, and the insurance company typically limits the rate of return on that money to about 10-12%.

You also might want to consider no-exam universal life insurance. As its name implies, this type of insurance doesn’t require a physical during the application process. It is usually much more expensive than standard life insurance, and smokers or people with existing health conditions sometimes aren’t eligible. For more information, see no-exam life insurance.

What is Supplemental Life Insurance?

If you have a full-time job, there’s a good chance your employer provides some level of life insurance coverage, often called group life insurance. However, group coverage is usually relatively low – about one to two times an employee’s annual salary. This often isn’t enough, however. 

That’s where supplemental life insurance comes in. This is additional group life insurance you can purchase through your employer, and as such it has the same primary advantage as all group life insurance: you won’t need to take a medical exam. However, some employer-provided supplemental life insurance only pays a death benefit if the employee dies or is critically injured in an accident; other causes of death may not be covered. Employer-provided supplemental life insurance also isn’t portable, so if you leave your job for any reason, your coverage goes away. Supplemental insurance through a private carrier has none of these limitations, so it might be a good alternative if you’re willing to undergo a physical.

Universal life and whole life are both types of permanent life insurance. They both accumulate cash value that can act as a savings mechanism. 

One primary difference is that universal life is usually less expensive than whole life because the insurance company offers a lower guaranteed interest rate. Universal life is also more flexible. While whole life charges level premiums and pays a specified death benefit, universal life allows you to pay your premiums at different amounts throughout the life of the policy and increase your coverage if you qualify. You also can decrease your coverage to a certain point, although if you lower it too much you will surrender the policy. 

Unlike whole life, the interest rate for universal life fluctuates with a market index. This means that the policy could underperform, which will lower the accumulated cash value and could result in higher premium payments. 

On the other hand, a universal life policy can perform better than a whole life policy when the market does well. The upshot is that whole life provides more certainty with level premiums and a guaranteed interest rate, while universal life has adjustable premiums with more upside and downside investment risk.

Universal life insurance is a form of permanent life insurance that remains in effect as long as premiums are paid until the maturity date. By contrast, term life insurance is only effective for a given period of time. Term life is usually cheaper than universal life, but it isn’t nearly as flexible and doesn’t accumulate cash value. A universal life policy allows you to adjust your premium payments and death benefit, and is the better option if you want to use a life insurance policy as a savings or investment vehicle. If you just want to provide for your loved ones, however, term is probably a better choice.

How Much Is Universal Life Insurance?

The following chart lists average monthly rates for term, universal life, and whole life insurance for a non-smoker female who falls in a Standard Plus risk class (average health) and is buying a policy with $1 million in coverage. For universal life, she would pay an average rate of $531.82 per month at age 30 and $1,635.44 at age 60. 

Universal life insurance is considerably more expensive than term. For example, for a 10-year term policy, our sample female would pay an average of just $36.20 per month at age 30 and $234.67 at age 60. 

On the other hand, whole life insurance is even more expensive than universal life, with average rates for our sample female of $706.25 per month at age 30 and $2,886.50 at age 60.

How Much Life Insurance Do I Need?

Determining how much life insurance you need is a critical step when buying a new policy. Too much coverage will result in excessive premium payments, but too little will leave your loved ones without adequate financial protection. The goal is to strike the right balance. 

To calculate your coverage level, first consider why you want life insurance. Most people primarily want life insurance to provide financially for their loved ones, but it can serve several other purposes as well. For example, it can help pay off long-term debts after you die, ensure that a business can keep going if a high-level employee passes away, pay estate taxes, and pay for burial expenses. 

Other considerations include how many people depend on you financially, how many years they will continue to depend on your income, any other income and assets your beneficiaries will have when you die, and whether you want them to be able to maintain the same standard of living. Finally, think about how to replace 401(k) matches and health insurance subsidies from your employer, as well as any other “hidden income” that will no longer be available upon your death and that your beneficiaries might have to replace.

Once you have discussed all of these factors with a financial counselor and your beneficiaries, you will be in a good position to determine how much life insurance you need. For more about calculating your life insurance needs, see How Does Life Insurance Work?

Best Life Insurance Companies

We don’t rate the best universal life insurance companies specifically, but many of our Best Life Insurance Companies offer universal life insurance policies. Visit the Best Life Insurance Companies of 2021 page to find the best company for you.

#1Northwestern Mutual
#2Haven Life
#3State Farm
#4Banner Life
#5Principal
#5Pacific Life
#7Guardian Life
#7Nationwide
#7Primerica
#7MassMutual
#11New York Life
#11Allstate
#13John Hancock
#13 Protective
#15Mutual of Omaha
#15Prudential

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