Universal Life Insurance

Universal life insurance is similar to a whole life insurance in the sense that both are permanent life insurance policies that combine lifelong coverage with a “savings account.”

If the policy holder does not default on his premium payments, his policy will not expire and death benefits will be given to his named beneficiary. 

A universal life insurance comes with a cash value feature similar to a whole life policy but with more flexibility. Unlike a whole life policy, premiums, savings element, and death benefit with a universal life insurance policy can be modified to suit the policy holder’s current situation. 

Features of a Universal Life Insurance Policy

• Death benefits increase and decrease, as needed based on policy holder’s current situation.

• A locked-in death benefit not subject to an increase or decrease while the insurance policy is in force.

• The cash value fund can be used to cover the cost of premiums allowing you to skip premium payments. This is only applicable when there is enough cash value fund. In the first year, however, you cannot use your cash value funds to offset premium payments.

• When the cash value fund is used to pay for premiums, the amount needs to be repaid with added interest. 

• In most cases, you can borrow against your cash value fund

• The cash value of your policy can grow on a tax-deferred basis. 

 

Benefits of Universal Life Insurance

Similar to other types of life insurance policies, a universal life policy aims to offer financial protection and replaces the income of the policyholder when he dies. 

These types of life insurance policies are also used as an advanced estate planning vehicle after other tax-deferred/tax free options such as the 401(k) and IRA have been maximized. Many people also choose these options to minimize their tax obligations which they cannot do with other investment vehicles. 

How the Cash Value Works

Universal life and whole life are permanent insurance policies. Their main difference is on how each life insurance policy accumulates cash value. 

• Interest Rate

If you have a universal life insurance policy, the life insurance company sets a minimum interest rate, usually 2%, on the contract for your policy. This is how the cash value accumulates funds. 

If the overall investment portfolio of the life insurance company increases in value, a portion of the gain is added to the cash value of the universal life policies of the company up to the maximum percentage stipulated in the policy. 

If on the other hand, the investment portfolio of the insurance company does not gain or lose in their investment, the insurance company, as obligated, still needs to pay the minimum interest rate stipulated in the policy contract. It then becomes part of the cash value fund.

The life insurance company can invest cash value in a policy at any major stock index or money market account. It can also be invested in bond funds and equity funds. 

• Payment of Premiums

The main advantage of the cash value of a universal life insurance is that the funds can be used to pay for the premiums of the policy on the second year. This is only possible though if the cash value has enough funds for the cost of the insurance. There are however limitations on how long this can be done.

On the other hand, if you default on a monthly premium with your whole life insurance, a loan will automatically be made against the cash value of your policy. 

How to Use Cash Value 

There are two ways you can use the cash value build up of your universal life policy:

• Take a tax-free loan against it 

• Withdraw a portion of it which is subject to taxes

Make sure to consult your financial adviser before you withdraw funds from your cash value policy.

Keeping your Policy Updated 

The monthly premiums you make for your universal life policy go towards funding the insurance component including the death benefit and operational costs, and the savings component of your policy. 

The insurance component of your policy needs to be funded by your premium payments or by deducting from your cash value (if it has enough fund build-up). As long as the insurance component remains funded, your universal life insurance policy is guaranteed to stay in effect. 

How the Death Benefit Works

The death benefit can either be level or increasing. 

• Level Death Benefit 

In this type of death benefit, the amount of payout remains level throughout the term of the policy. The policy will payout whichever is greater - the cash value or the death benefit. 

• Increasing Death Benefit

The death benefit and cash value increase over time. Both form part of the death benefit payout.

Your end goals will dictate which is better between the level and increasing death benefits. It is best to speak with a licensed insurance agent to discuss your options.

Universal Life Insurance Structures 

Universal life insurance has three different structures and availability depends on the life insurance company. 

1. Standard Universal Life Insurance

 This type of policy offers individual coverage and there is only one insured person per policy. Almost all life insurance company has this type of universal life insurance policy.

2. Joint Universal Life Insurance

This type of policy covers two individuals. This is typically purchased by couples for the protection of the remaining spouse. The death benefit is paid out when the first person dies. 

There are instances however when purchasing a term life insurance rider for the spouse on another type of life insurance policy makes more sense than a joint universal life insurance. It is best to discuss your options with a licensed independent agent.

3. Survivorship Universal Life Insurance

This looks similar to a joint universal life insurance but payout is done after the death of both insured parties. This can be impractical for some people. It is however commonly used in advanced estate planning for purposes of estate taxes especially when the estate of the insured spouses is more than what the federal government allows for estate taxation. 

If the estate of the insured parties is less than 410 million, it is better to purchase a different type of policy. 

Types of Universal Life Insurance

1. Traditional Universal Life Insurance

This is the most popular universal life insurance policy. 

• Accumulates cash value at a slower pace but are safer than other types of universal life policies because the cash value amount is invested in money market accounts. 

• This policy is used by many people as a supplement to their retirement income because after retirement, they can take a loan against their policy.

 

2. Variable Universal Life Insurance

• Cash value account is attached to actual investment funds that are traded in bonds and equities.

• Cash value quickly increases making this a lucrative type of life insurance policy however the risk is greater as the cash value can be gone faster than they can grow due to severe downturns in markets.

• The fees associated with this policy make them unattractive.

You can speak with an independent FINRA registered adviser if you want to learn more about the variable universal life insurance policy. 

3. Indexed Universal Life

• These policies are invested in index funds that follow the S&P 500 or the same equity index. 

• Many of the options and features of this type of policy are similar to a traditional policy except for the larger gains.

• This type of policy is often used to supplement other investment options in long-term strategies that combine the growth of wealth with coverage protection. 

 

4. Guaranteed Universal Life

This type of life insurance policy is the most similar policy to a term life insurance. 

• Similar to a term life insurance policy except that it offers coverage for the entire lifetime of the insured person. 

• Builds up little to no cash value.

• Does not have the flexibility in terms of premiums as other universal life policies.

• Cheaper than traditional policies. 

 

Pros and Cons of the Universal Life Insurance Policy

Pros

• Flexibility. Financial needs often change over time. You may want to pay less premiums during economic downturns to minimize possible loses or you may want to just pay the minimum premium required for your policy to remain active. Depending on the type of universal life policy you have, you can customize your coverage in many ways.

• Permanent coverage. This policy provides life insurance coverage during the lifetime of the insured as long as premiums are updated.

• Tax-deferred growth. All growth in universal life insurance policies is tax-deferred. This means you will not immediately be bothered by the IRS for taxes on your gains.  Before you withdraw money from your policy, make it a point to discuss with your independent financial adviser any tax obligations.

• Access to cash value. You can take a loan against the cash value or withdraw funds if needed.

• Cash accumulation choices. You can choose where you want your cash accumulation to go. This of course depends on the type of policy you have. 

Cons

• Cost of insurance. You can choose between a level cost and a yearly renewable term type of universal life insurance. 

In a level cost of insurance (LCOI), the insurance company computes the total cost to insure and individual and keeps the premiums level. This means the premiums never change for all through the life of the policy. 

A yearly renewable term is like buying a new term life insurance every year. This means there will be a gradual increase in cost. With this method, the overall cost is lower during the early years but eventually becomes more costly as the policy continues. 

• Higher cost. These policies can cost about five times more than traditional term policies because of the higher premiums and fees.

• Cash value monitoring. Variable and indexed policies are suitable for people who have knowledge in making investments because cash value performance of these policies has to be closely monitored.

• Loans Repayment. Taking a loan against your universal life policy comes with an interest and lowers your death benefit as well.

• Extra-low interest rates. Most policies have interest rates conservatively pegged at 2-3%. These interest rates are extra-low they cannot even offset inflation. Owing a universal insurance policy will not make you rich.

Universal Life Insurance vs. Whole Life Insurance

• Flexibility of premiums 

A universal life insurance allows the use of cash value to pay for premiums, when needed, as long as insurance cost is covered.  

Whole life insurance does not allow you to take advantage of these options.

• Tax Deferment

Both universal life insurance and whole life insurance policies allow for cash value tax deferment and allow the insured individual to take a loan against the cash value.

• Death benefit

A universal life insurance allows the increase and decrease of death benefit.

A whole life insurance does not allow the increase and decrease of the death benefit 

• Payment of premiums Although not advised both the universal and whole life insurance policies allow you to skip payments of premiums as long as the insured meets certain conditions.

Skipped premiums are deducted from the cash value component of a universal life policy. 

Skipped premiums for a whole life insurance can be paid by taking a loan against the cash value of the policy. It must be however paid back with interest.  

• Interest Accumulation

Accumulated interest for a universal life insurance is adjusted monthly making the cash value growth faster. 

Accumulated interest for a whole life insurance is computed annually making the cash value grow slower. 

Universal Life vs. Term Life Insurance 

Universal life insurance combines the best features of a permanent life insurance and term life insurance making it a “hybrid” type of life insurance policy. Some unique features have also been added to differentiate it from other life insurance policies. 

• Cash value feature  

A universal life insurance has a cash value feature. 

A term life insurance does not come with a cash value feature  

• Length of protection  

A universal life insurance offers protection for the entire life of the insured person. 

A term life insurance offers protection for a predetermined period of time. 

• Calculation of premiums 

While both the universal life insurance and term life insurance use the same computations to arrive at the premium amount, a universal life insurance calculates premiums until age 100 and then charges the average price for coverage premium. 

This is the reason a universal life insurance policy is more expensive than a term life insurance policy. 

Frequently Asked Questions about Universal Life Insurance

1. How much does a universal life insurance policy cost?

Just like any form of life insurance policy, it depends on the policy you are buying and the life insurance company you are buying it from. As a point of comparison, it is less expensive than a whole life insurance and more expensive than a term life insurance.

2. Is a universal life insurance policy a good investment?

Depending on the reasons for buying a life insurance policy, the universal life insurance can be a good investment. 

Many people want to have a basic and simple coverage with the least cost. If you are looking for such a life insurance policy, a universal life insurance policy may not be your best option.  

Many people know that a universal life insurance is not the least expensive policy, if you are looking at having coverage for life combined with a savings plan.

The decision of whether a universal life insurance policy is a good investment depends on the features you are looking for in a life insurance policy. 

3. What is the best way to buy a universal life insurance policy?

There are exclusive agents that sell universal life insurance policies but they can only offer you the ones sold by their respective companies.

An independent insurance agent (e.g. Aha personal shoppers) can offer you universal life insurance policies from different life insurance companies. This allows you to compare prices and features so you get the best underwriting and price for your particular situation. 

4. Where is the best place to buy universal life insurance? 

The best place to buy a universal life insurance policy is through an independent agent (e.g. Aha). An independent agent acts as your personal shopper and checks all possible life insurance companies to provide you with all possible options. 

Independent agents know even the smallest details about the underwriting requirements of life insurance companies. They can also ensure that you are getting coverage from a life insurance company that is a perfect fit for your needs.  

5. When is the best time to buy a universal life insurance policy? 

It is always best to buy a life insurance policy when you are still young. At a young age, you are less likely to have a medical problem and a lower risk of death- all of which will negatively impact the cost of premiums. 

6. Why can a universal policy not be a good option?

A universal life insurance policy is not for everyone. Most people do not want or need a permanent policy because of its lifelong coverage and are happy with a term life insurance. 

Whether or not a universal life insurance plan is a good or bad option for you depends on how you want your life insurance policy to work for you as well as your long term plans. 

It is best to speak with an experienced and professional insurance agent to discuss whether a universal life insurance is a perfect fit for you. 

February 3, 2020 - Reading time: 66 minutes