Universal Life Insurance was introduced by the insurance industry when “buy term and invest the difference” began to catch on and interest rates were skyrocketing.
This type of cash-value life insurance provides a guaranteed death benefit and a cash-value component that allows the policy to accumulate wealth while earning a minimum interest guaranteed by the insurance company.
Unlike term and whole life insurance policies, Universal Life (UL) is also flexible and allows the policyholder to change premium payments and the death benefit to accommodate life events that everyone experiences during their lifetime.
Universal life is considered a long-term investment because after the policy accumulates considerable wealth, the policyholder can access those funds via policy loans or partial withdrawals which are tax-free up to the amount of premium paid in.
How UL Works
Universal life is set up so that a portion of the premium paid covers the cost of the life insurance (annually renewable term insurance) plus any policy fees and the remainder is placed in a cash-value account that earns interest on a tax-deferred basis.
The interest credited each year will depend on the performance of the insurance company’s investments but will never be less than the guaranteed minimum rate stated in the policy.
Policyholders have options for how the accumulated cash value can be used and this is one of the main reasons that make universal life so popular. The insurance policy is an asset and as such, there are several ways that a policyholder can benefit financially as well as provide a tax-free death benefit for surviving loved ones.
How Universal Life Cash Value can be Used
Certainly, the most popular benefit of universal life insurance is that it has a cash account that accumulates wealth overtime. In fact, in many cases, universal life insurance is a solid solution for individuals who can’t seem to save money.
If you need life insurance protection anyway, why not pay extra each month and earn tax-deferred interest at the same time? As your cash account grows, you will have options as to the best way to use it:
Savings Account – The insured can treat the cash account as a savings account and withdraw money for any reason via policy loans and then pay it back however he or she pleases. Or, the loan doesn’t have to be repaid at all. The insurance company will simply deduct any outstanding loans from the cash account if the policy is surrendered or from the death benefit if the insured dies.
Paid-up Insurance – When the cash account accumulates sufficient funds, the policyholder can stop making premium payments because there will be enough money in the cash account along with the interest earnings to keep the policy in force for a lifetime.
Retirement Income – Many UL policyholders use the cash account in their UL policy as an income stream when they retire. Since significant cash accumulates over time, the policyholder can simply take out a policy loan each year and not pay it back. When the insured dies, the unpaid loans will be deducted from the death benefit before it’s paid to the beneficiary.
The Flexibility of Universal Life Insurance
Universal life’s flexibility is another reason UL is so popular. When you purchase term or whole life insurance, the periodic premiums and the death benefit are pretty much locked in and cannot be changed.
With universal life insurance, a policyholder can skip a payment, increase their payments, or lower their payments to accommodate changes in their financial situation. Many policyholders pay more than the minimum premium so that their policy will accumulate cash quicker.
The death benefit is flexible as well. For most people, as they age and reduce debt, their life insurance needs are reduced as well. If you have universal life insurance, you can reduce your death benefit and your minimum premium will also be reduced accordingly.
Many companies will also allow an insured to increase the death benefit. Whether the policy must go through medical underwriting again typically depends on the amount of the increase. Once again, however, the ability to change the death benefit is another reason to choose universal life rather than whole life insurance.
Different types of Universal Life Insurance
Over time, insurance carriers realized that universal life insurance could not only accommodate the needs of people wanting to financially protect their families, but it could also be used in retirement planning. For that reason, the life insurance industry has responded with options to accommodate insurance shoppers.
Guaranteed Universal Life
Guaranteed Universal life which is the most recent entry into the marketplace is simply a UL policy that guarantees a level premium and guaranteed death benefit up to the age you select when you purchase the policy. Most companies will offer policies with a guaranteed death benefit from age 90 up to age 120. The cash value in these policies remains minimal since the funds are used to pay the cost of insurance. Guaranteed UL is beginning to gain popularity in the final expense market and is becoming a great solution for seniors.
Indexed Universal Life
With Indexed Universal Life (IUL) the focus is on wealth accumulation rather than the death benefit. The cash account in the policy is linked to market indices and earns interest based on the performance of each index. IUL policies have a CAP rate that represents the maximum amount of interest the policy can earn in a reporting period and a FLOOR rate that prevents the cash account from losing money because of market downturns.
Variable Universal Life
Variable Universal Life (VUL) is similar to IUL except for the money in the cash account is invested in the stock market (mutual funds) rather than linked to market indices. The VUL is a non-guaranteed life insurance policy and the policyholder is risking their premiums rather than being protected with a FLOOR rate like in the IUL. When the market is performing well (as it has over the last two years) this policy can accumulate significant wealth but if the market performs poorly, the policyholder may have to increase their premium payments to keep the policy in force.
The Difference between Whole Life Insurance and Universal Life Insurance
Here’s the difference in a nutshell:
Whole life guarantees the death benefit for life, guarantees the cash value and guarantees the premium – period.
Universal life insurance assumes an interest rate and the cost of insurance and comes up with a projected premium. If the insurance companies’ projections on their universal life policy do not come through, then you may have to come up with higher premiums later, have lower than expected cash values or even lose the policy.