What Is Universal Life Insurance?

Universal life insurance is a life insurance policy with permanent coverage that issues a cash payout to your beneficiaries at any age you die (assuming you keep up with your premium payments). Premiums may be flexible, allowing policyholders to increase or decrease their payments within limits. Universal life policies also have a cash value component that builds equity over time.

Keep reading to learn what is a universal life insurance policy and how it works.

How Does Universal Life Insurance Work?

As a type of permanent life insurance, a universal life policy offers mostly lifelong coverage (typically up to age 121) and issues a death benefit to your beneficiaries in the event of your death. Coverage will be maintained so long as you continue fulfilling your premium payments — otherwise, your policy will lapse and no death benefits will be issued after you die.

With premium flexibility, universal life policyholders can increase or decrease their premium payment within limits. Decreasing your life insurance premium can help cover necessary expenses when your budget is stretched thin. Or, you can increase your premium to encourage more growth in your cash value account.

How Cash Value Works

Each time you make a premium payment, a portion of that payment is deposited in a separate cash value account that accrues interest over time. The interest rate is generally low (e.g., 2% annual growth) but may be guaranteed by some insurers. Some insurers allow you to invest that cash value in market-based investment options to potentially increase your rate of return.

Once your cash value reaches a certain level, your insurer may allow you to use it to pay for your premiums. However, your policy will lapse if you skip a premium or there is no cash value to cover your payment. Policy lapses forfeit your death benefits, which means your beneficiaries will not receive any cash payout when you die.

Some insurers allow you to take out a loan using the cash value as collateral. This can be useful for financing major life expenses, like your child's education or settling an existing debt. You will still be required to repay the loan plus interest like any other type of loan. If you die before you repay the loan, then the outstanding balance gets deducted from your death benefits, decreasing the cash payout issued to your beneficiaries.

You can cash out the equity in your cash value account early by surrendering the policy. This will cancel the policy and your beneficiaries will not receive any death benefits after you die. Be sure to ask your insurance agent about applicable surrender fees.

You can decrease your premium or you can increase it if you want to contribute more to your cash value growth.

What's the Difference Between Whole Life and Universal Life and Term Life Insurance?

Whole life, universal and term life are common types of life insurance. Below, we explain the differences between each.


Whole Life

Universal Life

Term Life

Coverage Period

Lifelong coverage

Lifelong coverage

Typically 5-30 years

Flexible Premiums

Not flexible

Can increase/decrease within limits

Not flexible

Cash Value Growth

Lower, but guaranteed interest rate

Minimum guaranteed interest rate that may increase based on market performance

No cash value

Cost

More expensive than term life

More expensive than term life

Less expensive than whole life and universal life

Premium Increase

Does not change

Flexible

May increase with each term renewal

Differences in Coverage

Both whole life and universal life policies offer lifelong coverage, paying out death benefits after any age you die, assuming you continue paying your premiums.

Term life policies, on the other hand, have fixed coverage periods that typically range from five to 30 years. Some terms are as short as one year. If you are still alive when your term expires, then you will no longer have any coverage unless you renew your policy.

Differences in Premium Flexibility

Whole life and term life policies typically have fixed premiums throughout the policy life or a fixed term (for term life). That means you will not be able to increase or decrease your premiums.

With universal life insurance, you have more flexibility over your premium payments depending on your insurer. You can temporarily decrease your premium if you need more breathing space in your budget or you can increase it if you want to contribute more to your cash value growth.

Differences in Cash Value Growth

Both whole life and universal life policies have a guaranteed interest rate that is typically on the lower side. However, universal life policyholders may have the option to invest their cash value in market-based investment options. This allows for a potentially higher rate of return for universal life insurance over whole life insurance.

There is no cash value component in a term life policy.

Interest rate growth based on market performance is one potential advantage of buying universal life insurance over whole life insurance.

Differences in Cost

Term life insurance is generally less expensive than permanent life policies, like universal and whole life insurance. The tradeoff, however, is temporary coverage. When the term expires, then you will no longer be covered unless you renew the policy.

Differences in Premium Payments

Whole life insurance premiums are level — this means that they will not change throughout the life of the policy. The premium you paid when you bought the policy at 25 years old will be the same as when you are 80 years old.

Term life policy premiums can increase each time you renew the policy to account for your increased age. Universal life insurance premiums function a little differently because they are flexible and you can increase or decrease them throughout the life of the policy.

Compare Universal Life Insurance Policy

Pros and Cons of Universal Life Insurance

Pros

Cons

Lifelong coverage

Complex

Flexible premiums

Potential to lapse

Tax-free cash value growth


Loan collateral


Once your cash value reaches a certain level, your insurer may allow you to use it to pay for your premiums.

What Are the Benefits of a Universal Life Insurance Policy?

  • Lifelong coverage: Your beneficiaries are entitled to death benefits whether you die at age 50 or 100, so long as you maintain your premium payments before your death.

  • Flexible premiums: Your premiums may be increased or decreased within limits, which can be useful if you have fluctuating income or your finances are temporarily strained (e.g., you were laid off from your job or you put a down payment on a house).

  • Tax-free cash value growth: Your policy's cash value is not taxed until it is issued to your beneficiaries after you die or if you cash it out early.

  • Loan collateral: You may take out a loan against your life insurance policy, using your cash value account as collateral. You may use these funds however you want, such as contributing to your child's education or paying down an existing debt.

  • Market-based performance: Your insurer may allow you to invest some of your cash value in market-based investment options, which can increase your rate of return.

What Are the Disadvantages of Universal Life Insurance?

  • Complex: With investment security options to consider, the ability to adjust premiums and more, there is much more to manage with a universal life insurance policy compared to a simple term life policy.

  • Potential to lapse: If you have sufficient cash value, then you can use it to cover some of your premium payments. However, if there is not enough cash value and you cannot meet your premiums, then your policy can lapse and your beneficiaries will not receive any death benefits after you die.

Who Typically Chooses a Universal Life Insurance Policy?

If you're seeking lifelong coverage and want to build cash value, then a universal life insurance policy may be worth considering. With lifelong protection, your beneficiaries will be entitled to death benefits at any age you die. Moreover, each premium payment you make will go into a cash value account that grows on a tax-deferred basis.

Interest rate growth based on market performance is one potential advantage of buying universal life insurance over whole life insurance. Whole life policies typically earn interest at a guaranteed but lower rate, such as 2% annually. Some universal life insurers also offer a lower, but guaranteed minimum rate but also allow the cash value to get invested into certain investment securities. This could potentially allow for a higher rate of return than a whole life policy.

A universal life policy offers lifelong coverage and issues a death benefit to your beneficiaries in the event of your death.

Premium flexibility is also a notable advantage. Life rarely goes as planned, and unexpected expenses can arise. Lowering your premiums during cash flow dips can help you manage those emergency costs. You can also later return to your normal premium payment or a higher one when your financial situation improves.

FAQs

What is indexed universal life insurance?

Indexed universal life insurance is a life insurance policy with lifelong coverage and a cash value component. Cash value growth is based on the performance of a stock market index, like the S&P 500 or Russell 2000 but this policy typically places a cap on how high a return rate you can get.

What is variable universal life insurance?

A variable life insurance policy offers lifelong coverage with a cash value component that can grow based on a variety of investment options and is not limited to just stock market indexes, like indexed universal life insurance. There is typically an interest rate cap that can limit your cash value growth.

What is guaranteed universal life insurance?

Guaranteed universal life insurance offers coverage up to a specific age instead of a fixed term (e.g., 15 years, 30 years) like a term life policy. There is also a cash value component that can accrue equity over time but typically not to the level of other permanent life policies.

Can you cash out a universal life insurance policy?

You can cash out the accumulated cash value universal life insurance policy by surrendering your death benefits. You would be able to receive the built-up cash value, minus surrender fees, but your beneficiaries will not receive a death benefit after you die.

Are life insurance premiums tax-deductible?

Life insurance premiums are generally not tax-deductible and you will need to report that spent income when filing your IRS taxes. There are some exceptions, such as transferring ownership of your life insurance policy to a qualified charity.

Lifelong Coverage at an Affordable Price

Lifelong coverage and building cash value are some of the long-term benefits of having a universal life insurance policy. However, a permanent life policy, like universal life insurance may not be the right fit for everyone. Depending on your situation, temporary coverage with a term life policy may be a better fit. Or you may prefer the simplistic coverage and cash value growth that a whole life policy offers.

Whatever life insurance needs you're looking to fulfill, SmartFinancial can help you snag the best price. We compare policies from hundreds of insurance carriers in your area to ensure you're getting the best policy available. Start receiving free quotes by entering your zip code below and answering a few questions or calling 855.214.2291.

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