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Have you started shopping for life insurance only to find yourself overwhelmed with the various plans and options? We understand the importance of choosing the right plan without breaking the budget. Let us help you sort things out with this guide to universal life.
One of the most innovative plan offerings from insurance companies today is universal life insurance. As a permanent life insurance plan, universal life combines the affordability of term insurance with the value offering of whole life insurance to give you the best of both worlds. This guide to universal life insurance will arm you with the tools you need to be an expert shopper.
If you’re anxious to get started with a quick quote, enter your ZIP code in the FREE quote tool above and get your first quote today.
What is universal life insurance?
Universal life insurance is a type of permanent life insurance, meaning that it provides coverage throughout a policyholder’s lifetime. Similar to traditional whole life insurance and in contrast with term insurance, coverage will never expire as long as premium payments are made on time.
Similar to traditional whole life insurance, premiums paid for universal life insurance are composed of two components. Part of your premium goes toward the cost of administering the policy and covering the death benefit. The second component of the premium goes toward building cash value.
Universal life varies from traditional whole life in a few ways.
Although both policy types provide coverage for your entire lifetime and both offer the ability to build cash value over time, universal life offers you more flexibility in managing premiums and death benefit coverage amounts.
The key difference is that universal life allows you to vary the premiums over time, while traditional whole life maintains constant premiums.
With universal life, you can choose to stop premiums or reduce the amount of each premium payment.
Accordingly, varying premium payments will affect death benefits or cash value. Paying higher premiums will allow you to build more cash value, while paying lower premiums may be just enough to sustain the death benefit amount of the policy.
Before locking in a policy, you should clearly understand the maximum and minimum premium commitments and ensure that you can make payments within that range.
You should also understand that making minimal premium payments could result in little to no cash value in the premium over the life of the policy.
A second difference is that although both policy types feature a cash value component, excess premiums that are paid into a traditional whole life policy are invested at the insurance company’s discretion.
For universal life policies, you’re given options for earning a return on the cash value component of a policy. Options can include fixed income products or riskier mutual funds and equity products.
Because of this, returns for universal life products can be higher.
According to the National Association of Insurance Commissioners (NAIC), insurance companies developed universal life policies during the 1980s to give consumers a way to get better returns on the cash value of their policies.
During periods of low interest rates, consumers balked at whole life insurance policies and instead opted for buying much cheaper term life insurance and investing any additional dollars elsewhere.
To win consumers back, universal life policies were introduced with the potential for better returns on money contributed for permanent coverage.
The video below provides a great overview of universal life insurance and the types of universal life insurance we’ll explore in more detail later in this article.
With this basic understanding of universal life insurance, let’s consider who universal life insurance benefits.
Who Should Consider Universal Life Insurance
Universal life is a way for consumers to get permanent whole life coverage while benefiting from a built-in savings vehicle. As with most insurance policies, getting a universal life policy at a younger, healthier point in time will give you the chance to lock in lower premiums for the maximum benefit.
Universal life policies take time to build value. For instance, if you’re paying a premium of $10,000 per year for a benefit of $150,000, it would take you about 15 years of making premium payments before you effectively build any cash value.
Because of these factors, consumers considering universal life insurance should not think of it as an investment.
Instead, think of the cash value of your policy as a means to support premiums later in your lifetime when you may be on a fixed budget.
You may want to consider universal life insurance as an option if you fall into one of the following groups:
If you aren’t great with putting money away for a rainy day, having a policy that gives you the ability to build cash value can be a way to force yourself to save. If you’re younger, by the time you need it, you may have a nice rainy day fund.
For some people looking for permanent life insurance, a whole life policy may not be enticing because of the limited potential for gain on any cash value. These policyholders may be concerned with committing to a costly fixed premium that will return only a limited gain.
People who are comfortable with a bit of risk or have a longer timeline for when they need the funds may want the chance to maximize potential gains. This also allows them to divert some funding away from their universal life policy if other opportunities arise.
You shouldn’t look to a universal life plan to substitute true investment tools such as tax-deferred 401(k) plans or traditional IRAs.
For younger couples, term insurance might be the most affordable option, but the idea of having to find new providers or renew insurance every so often may not be appealing. Younger couples may also want to take advantage of getting lower-cost insurance while they are young and healthy. However, committing to fixed premiums may be worrisome.
Universal life offers an option to get permanent insurance with the flexibility to change the premium with your needs.
Universal life plans also provide the ability to change premiums or benefits over time. This can be especially helpful since you expect your needs to change throughout your life.
As your policy gains value, you might benefit from the option of taking a loan against the value of your policy to purchase a car or a house. If you go through periods of lower cash flow, you can opt to lower your premium payments for a while.
You could also potentially get to a point where the cash value of your policy is substantial enough that the policy can sustain the premium payments itself.
If you’re approaching retirement and are looking to get permanent life insurance, you may be concerned that you can’t afford to make current premium payments to get the death benefit amount you would like.
Since you’re still earning income and can afford to pay higher premiums now, you can contribute as much as possible to your universal life plan and decide to invest it in options that will give you the best chance at a higher return.
As you approach retirement, you can adjust your investment options to manage risk and decrease your premium payments, but use your cash value to support your plan and maintain the death benefit target.
In fact, if your plan’s cash value growth is sufficient, you could come to a point where you no longer need to make premium payments at all.
What is a universal life maturity date?
Although permanent life insurance implies that a policy will continue forever, most universal life policies have a maturity or endowment date defining a final date when the cash value of the policy will be returned to the policyholder.
This universal life policy maturity date is usually determined when the policy is written and is set for a birthday of the policyholder so far into the future that the policy would probably have been surrendered or the benefits been paid before that date.
Universal life maturity dates are set for somewhere between the 100th and 121st birthday of the policyholder.
If the policyholder does live to the maturity date, the policy will expire and payment will be made to the policyholder.
You should know your universal life maturity date for two reasons.
First, if you’re fortunate enough to be healthy when you arrive at your maturity date, you’ll no longer be insured. At such a late age, you may not be able to get new coverage. In this case, you might need to keep any surrendered payments to manage your final expenses, since you will be uninsured.
Second, if you live long enough to expire your policy, your provider will pay you the policy value. This could result in a payment amount that is lower than the expected benefit.
Traditionally, if a policy is paid upon the death of the insured, the beneficiary receives the benefit without triggering an income tax event.
However, if you receive a payment at the expiration of your policy, any value that exceeds the value of the premiums paid for the policy could be considered income.
This could result in a significant amount of taxes due, which could be a large percentage of the overall cash value in the plan. If you know your maturity date, you may be able to get a maturity extension beforehand to avoid any issues.
Types of Universal Life
There are three main types of universal life insurance. All three types provide permanent insurance, but the type of plan you choose will determine the type of investments that are made with the cash component of your premium. The three types of insurance are:
- Traditional universal life
- Indexed universal life
- Variable universal life
We’ll go into detail to define each type of insurance next, but if you’re interested in jumping ahead to get a free quote, use our FREE quote tool below. Just enter your ZIP code to get a quote instantly.
Traditional Universal Life (Non-Guaranteed)
Traditional universal life is like a whole life insurance plan in that it offers permanent insurance protection and the insurer guarantees a return on the cash value of your premium payments at a fixed interest rate. However, unlike a whole life policy, you won’t be locked into a premium for the life of the policy.
This is helpful if you ever need to postpone making premium payments for a while. With a universal life policy, as long as the cash value amount is enough to cover the minimum premium, you can stop making payments without losing coverage.
Since traditional universal life policies provide a return against a fixed interest rate, you won’t be subject to the risk of market fluctuations, but you’ll be limited by the amount of return you’ll receive for the cash value of your policy.
Any gains on your cash value are tax-deferred, meaning that you won’t have to pay income tax on any returns unless you surrender or expire the policy and have your money returned to you.
Who Should Own Traditional Universal Life
If you’re considering permanent life insurance but are concerned with locking yourself into a lifetime of premium payments, a traditional universal life policy could be a good fit for you.
With a traditional universal life policy, reliable fixed interest returns on your cash value contributions will allow you to determine exactly how much you will have at a certain point in time. Consider the following scenarios:
- A young family provider wants to lock in an affordable permanent insurance plan at a lower cost now to avoid the burden of making payments later. They make a contribution that meets the policy needs and builds cash value so that when they turn 65, the cash value with interest earned can pay the remaining premium payments for their expected lifetime.
- An empty nester approaching retirement wants to ensure that when they turn 75, they won’t ever have to make another premium payment. They plan to maximize the premium payments until retirement at 65 and then pay reduced premium payments for the 10 years until they are 75 so that their cash value will be enough to service the policy until they are 100. They can calculate compounding interest on their premiums to figure out exactly how much they should contribute today.
Traditional universal life is a great option for precise planning of coverage and doesn’t expose you to fluctuations in the cash value component external to premium payment adjustments.
How much does traditional universal life cost?
Traditional universal life quotes are often quoted as the lowest allowable premium. As a consumer, you should understand that if you’re making the lowest allowable premium, you won’t be building any cash value for quite some time, if ever.
In fact, traditional universal life should be designed to be expensive in the initial years so your contributions are building up cash value in the plan for later if you’re planning to have the cash value of the policy support premium payments at any time.
To calculate costs for a traditional universal life policy, you should speak to your agent and discuss how much you want and can afford to contribute, how much benefit you require, and when you might want to use any cash value in the policy.
Pros & Cons
A traditional universal life policy is a great permanent life insurance option to consider, but as with any insurance policy, the features of the policy should align with your personal needs and goals. Take a look at how the pros and cons below line up with your financial goals.
- Traditional universal life provides more flexibility than a whole life policy. This means you can adjust premium payments and death benefit amounts with the changes in your life.
- Your traditional universal life policy will have a cash value component that can build value over time depending on how much you pay in premiums.
- You can take a loan against the cash value component of your policy as an emergency lifeline.
- It takes time and planning to build value into your plan. If you only make minimum payments or need to stop making payments, your policy won’t build the value you expect over time.
- A universal life policy often carries yearly administrative fees and expenses, as well as surrender fees.
- Early surrender of a plan means that you’ll be paid out on any cash value in the plan. Any amount that’s paid over the premiums paid can be considered income and may require you to pay taxes.
Indexed Universal Life
To understand an indexed universal life policy, you first need to understand an index. For people who don’t regularly invest in equity markets, an index is a selection of individual investments grouped as a single financial tool.
For instance, you might have heard of the S&P 500. The S&P 500 is a collection of the stocks of 500 large companies in the United States that meet particular criteria.
As an individual investor, to invest in 500 companies, you’d have to do a lot of homework to understand what to buy and how much, have a lot of capital to buy stock and pay transaction fees, and do a lot of management to track changes as companies come and go.
Instead, large investment companies do this work for you and offer you the ability to invest in a single product, called an index.
When it comes to indexed universal life, your premium payment still gets separated into two components: the part that pays for your policy and benefit and the part that goes to building cash value.
However, for an indexed universal life policy, you have the option of requesting that your cash be invested in an index that has the potential to give you a better return over time.
The video below provides a good summary of how indexed life insurance works.
If you’re considering buying an indexed universal life plan, remember that this is not a substitute for investment. Unlike an investment, an indexed universal life plan protects you from downside risk.
If the index performs well, your cash value receives a percentage of the return. If the index has a negative return, your cash value doesn’t change or decrease.
Who should own indexed universal life?
Since an indexed universal life plan has the potential to return higher gains on the cash value of the plan, consumers comfortable with market fluctuations may prefer an indexed universal life plan versus a whole life plan or traditional universal life.
Let’s say you’re thinking about retiring in 15 years. You’re willing to put in the maximum amount of premium allocation until then to receive $100,000 in benefits and have enough cash value for the plan to pay for itself when you retire.
You realize that with a traditional universal life plan at current offered interest rates, your plan won’t be able to support the payments for your benefit at retirement. You’ll likely need to continue making premium payments.
An indexed fund could be a better option. Index funds have the potential for beating interest rate returns by a few percentage points each year. In years where the index or fund underperforms, your indexed universal life guarantees you a predetermined interest rate return, and you avoid any losses.
With compounding gains, you could end up amassing enough cash value to support your plan premiums when you retire.
The risk is that you don’t match historical performance. However, if you’re diligent in tracking your plan, you have the flexibility to adjust premium payments over time.
If you’re looking at an indexed fund, you’ll want to make sure that you have a longer timeline to meet your goals if your index allocations underperform. You also want a clear goal in mind.
If you’re looking to maximize the amount of benefit for your beneficiaries, you should still have a defined goal determined for the cash component of your plan. You don’t want to tie up all your money in an insurance policy at the expense of foregoing true investment options.
How much does indexed universal life cost?
Indexed universal life premiums are determined the same way as traditional universal life premiums. Your policy premium is quoted at the minimum offered rate. To have any significant cash value in your plan, you’d need to pay higher premiums, at least initially.
You also need to understand what your actual return will be on any value that is invested. For your plan, you should speak with your agent to understand the following:
- How often gains are credited — daily, monthly, annually, or other.
- What fees will be charged for managing the plan
- The participation rate of the plan
Understanding the participation rate is especially important. Your insurance provider will set a participation rate, which is the percentage of gain that is actually credited to your plan.
This is important to understand because you don’t receive the full value of any gains for a select period. Instead, you receive the percentage of gain defined by the participation rate.
For example, if your plan has a cash value of $10,000 that’s tied to an index that provides a 10 percent return in the current period, you may expect your cash value to rise to $10,100. However, if the insurer sets a participation rate of 75 percent, your actual credit will be $75 and the fund value will be $10,075 at the end of the period.
Pros & Cons
Indexed universal life provides you with permanent life insurance and the potential for solid returns on your cash value allocations, but these plans are not for everyone. Be sure to review the pros and cons below to help decide what is right for you.
- Universal life plans can provide higher returns than traditional plans with protection against downside risk to the cash value of your contribution.
- Plans offer flexibility and allow you to make adjustments to premium payments and death benefit amounts over time.
- Gains on the cash value of the plan are tax-deferred.
- Insurance companies can set caps on gains and set participation rates that limit performance in line with the index.
- Plans could incur high fees.
- You’ll need to manage your plan regularly and adjust premiums in line with the performance of the index to ensure that you’re on track to meet your goals.
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Variable Universal Life
Variable universal life insurance takes things a step further. Instead of offering indexes to define your cash value returns, a variable universal life policy invests your dollars into actual financial products that can include mutual funds, fixed income assets, and equities.
The information for how your money will be invested is outlined in a prospectus, which you should read and understand carefully.
A prospectus is a description of any type of investment fund providing information on how the fund is managed, who manages the fund, and how the fund invests its capital.
Variable universal life insurance has a high element of risk. With standard life insurance, you pay a premium and the insurance company offers you a death benefit down the road. In the interim, they take your premium dollars and invest. By getting positive returns, they can pay out on claims while turning a profit.
With variable universal life insurance, the risk is passed on to you. Your premiums are invested and, similar to index universal life, gains are periodically credited to your policy.
Unlike traditional or index universal life, with variable universal life, you can lose money. Variable life insurance shouldn’t be considered a short term savings vehicle. Since you’re investing in more volatile products, your cash value can have periods of gain and periods of loss.
However, you can move your cash value allocations to different investment options over time and can likely manage risk by investing in more volatile products when you are younger and move to more stable fixed-income products as you get older.
You should be aware that variable universal life will have different fees and expenses that could add up. Your prospectus may not provide all the information on fee structures, so ask for all materials before buying a policy.
Variable universal life policies will sometimes have provisions allowing you to take out a loan on the cash value of the policy. This can be helpful, but you’ll want to pay attention to the returns on the cash value of your policy to ensure that you always have a sufficient surplus to cover your loan.
Who Should Own Variable Universal Life
If there’s a risk of losing value in your policy and a potential for high fees, why would you want to invest in a variable universal life fund? The three reasons for owning a variable universal life fund are:
- The potential to maximize gains and increase cash value in your policy
- The ability to build tax-deferred value in the policy
- Flexibility and control in managing your own risk
For example, let’s say a couple is approaching retirement with adult children. They’ve built up a nice nest egg for themselves and won’t necessarily need to depend on life insurance to support each other’s lifestyle if one of them passes. Instead, they’d like to leave a nice inheritance for their grandchildren.
A variable universal life policy would allow the couple to pay premiums and invest their premium dollars maximizing potential returns. As they get older, they can manage their risk from equities to fixed income and build the cash value in the policy. When they pass, they can leave their grandchildren a death benefit that won’t be subject to federal income tax.
How much does variable universal life cost?
When you buy variable life insurance, the amount of premium depends upon the amount of death benefit you need and how much cash value you hope to achieve. However, there are several costs and risks that could make your policy expensive.
First, a policy can lapse if the cash value isn’t able to maintain the costs of the insurance. If fees are eating up the value in the policy and you’re unable or unwilling to contribute more, you could end up with a lapsed policy.
Because of this, to understand the cost of your policy, you should get a clear breakdown of the fees and policy expenses.
Finally, you could lose on the investments. If your policy is invested in securities that happen to take a slide at the very time that you’d like to borrow against the value of the policy, there may not be enough value to borrow.
As with any product that has volatility in pricing, you should work with a financial professional to develop a strategy for managing your policy.
Is variable universal life insurance really worth it?
The question of “whether variable universal life insurance is worth it,” is a difficult question to answer in a general way. It really depends on why the insured person is purchasing the insurance and how much investment experience they have.
Variable universal life Insurance has two parts. It has the life insurance side and the investment side. The contract owner is responsible for investing the cash portion of the account in a manner, which earns a steady return. The insurance company does not guarantee returns to the cash accounts. However, the returns are tax-free as long as they are a part of the insurance contract and the policy is still in-force.
Pros & Cons
Variable universal life insurance is a complex product. Although it can provide quite a bit of benefit if things go well, if misunderstood, it could be a risky option for insurance coverage. Before jumping in, make sure the pros and cons align with your personal objectives.
- With variable universal life, you can select the investments where you would like your funds allocated and match your investments with your risk profile.
- Variable universal life policies provide flexibility. You can adjust the amount of death benefit or change your financial objectives.
- You can borrow against the cash value of your policy.
- Gains from variable life plan investments are tax-deferred.
- Your investments can produce negative gains, which means you can lose some or all value in your policy.
- There are several fees and expenses that can add up over time.
- Variable universal life policies are still life insurance policies and not investment products, but carry quite a bit of risk.
Summarizing the Types of Universal Life
The different types of universal life insurance each have very specific features. If you’re looking into universal life insurance as a permanent insurance option for yourself, the table below can provide a good summary for you to compare.
|Traditional||Permanent life insurance with a cash value |
that appreciates at a predetermined rate until maturity
| - Potential for better returns than whole life insurance|
- Ability to achieve higher returns
|- Requires time before any value is achieved|
- Higher fees and expenses
- Tax implications for early cancel or withdrawal
|Indexed||Universal life insurance that features the ability |
to invest the cash value component of the premium into medium risk market index funds for higher appreciation potential
|- Potential for higher returns|
|- Capped gains vs market|
- Non-transparent management fees and expenses
- Instability of premiums
|Variable||Universal life insurance that features the ability |
to invest the cash value component of the premium into higher risk equity funds for higher appreciation potential
|- Opportunity to maximize benefits|
- Tax-deferred gains
|- Could lose value from bad investments|
- Higher fees from a managed portfolio
- Opportunity cost of performance vs market
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Common to all universal life plans is that part of your premium covers the insurance policy death benefit and plan expenses, while another part acts as a savings plan. As you become familiar with these products, understanding how value is created in your policy is important.
How Universal Life Builds Cash Value
Universal life policies are meant to grow in value over the duration of the policy. In the simplest form, if you pay a monthly premium of $10 per month or $120 per year and $6 is allocated to your plan expenses and death benefit coverage, the remaining $4 will be invested.
For a traditional life policy, this $4 is invested similar to a savings account. Your plan will have a defined interest rate and your plan will grow with compounding interest and new premium allocations over time. This helpful video from Allstate helps to explain cash value for different plan types.
For indexed or variable life insurance, the remaining $4 is invested into the underlying index or investment products that you choose. With indexed life insurance, you’re protected from downside risk if your index performs poorly, but your cash value will grow if your index performs well.
However, you should be aware that your actual return will be a percentage of the total return defined by your plan’s participation rate.
The downside risk for variable life is that it’s not hedged like an indexed universal life fund. This means your policy can lose value.
Variable life insurance will provide a return or loss based on the performance of the underlying investment. So, if you invest in a few stocks that return a 10 percent return, your $4 will gain $0.40. However, if your underlying investment returns a negative return of 10 percent, your cash will be reduced to $3.60.
Universal life insurance plans have a minimum and a maximum premium. The minimum premium amount is the lowest amount you can contribute to provide for the plan’s expenses and cover your death benefit. If you make only this minimum premium, your plan won’t accumulate any cash value.
The maximum cap for contribution is usually defined by your provider based on government rules and regulations.
Initially, you’ll need to make consistent premium payments to your plan. As you accumulate cash value, you’ll be permitted to miss payments or vary payment amounts with the understanding that any plan expense amount and contribution to your death benefit will reduce the cash value of your account.
So if you wait long enough for your cash value to grow large enough, you can build enough cash value that it can support your plan for your lifetime.
However, if your cash value is reduced to a point where it can’t support premium payments and expenses, your plan will lapse, and that could be costly.
Accessing Cash Value
Once you have cash value in your universal life insurance plan, providers will allow you to borrow against the plan value. Your maximum loan amount is approximately the amount of cash value existing in your plan.
Interest will be determined by the insurance company. Since interest rates fluctuate, the interest rate will be determined at the time of your loan.
When you take a loan from your insurer, you determine a payback schedule with interest. However, if you don’t pay back the loan, the insurer will pay itself back from the cash value in your policy. You can think of the cash value in your policy as collateral for your loan.
If you don’t pay the loan back before you die, you forfeit the cash value of the policy plus any interest that has accumulated. This means your death benefit can also be reduced.
If you do take a loan against your plan, you need to understand any tax consequences. Although the loan itself doesn’t trigger a tax consequence, if you’re ever considered in default of loan repayment, the IRS will consider that you received the proceeds from the value in your plan, which will then be considered income.
Canceling Your Universal Life Policy
You can cancel your universal life policy at any time, but it could be costly. For starters, insurance companies will usually have a surrender fee. Surrender fees will usually be higher if the policy is newer. The longer you hold a policy, the lower the surrender fee will be.
For example, a policy can be structured so that if you cancel in the first five years, your surrender fee will be as high as 10 percent and then be reduced over time to 1 percent.
Although your cash value and premium payments will be returned to you, any part of your premiums allocated to fees and expenses are forfeited.
If you cancel an index or variable universal plan you may also be exposed to market conditions. If you cancel at the wrong time, your potential plan value might be lower than you might have hoped.
Finally, you’ll want to speak with your financial advisor. Any gains you may have made could be subject to income taxes if you decide to cash out your policy
Pros & Cons
There is a lot to think about when it comes to universal life. Here’s a quick summary of the pros and cons.
- Universal life offers a cheaper permanent insurance option than whole life insurance.
- Since you have options for managing risk with different financial products, you can maximize tax-deferred gains for your plan’s cash value.
- As your needs change, you can adjust policy premiums or death benefits.
- You can borrow against the cash value of your account.
- Any capital gain increases in the value of your account are tax-deferred.
- Universal life plans take time to build any value. This makes plans expensive earlier on.
- Plans could have high fees and expenses which could affect the overall value of your plan.
- If you decide to cancel your plan, you could be exposed to income taxes and high surrender fees.
- Universal life plans require management. You’ll need to keep track of the performance of your policy, maturity dates, and fees.
For consumers shopping for permanent life insurance, the prospect of having to pay high premiums for an entire lifetime is unmotivating.
Although some other types of insurance, such as whole life insurance, offer the opportunity to build value and reduce premiums over time, universal life plans can be better designed to build enough value to help you pay for your insurance in your later years.
Depending on your risk profile, universal life plans can allow you to grow the value of your policy faster. The prospect of having your money working harder is appealing to all of us.
However, universal life insurance plans are not “set it and forget it” insurance plans. Universal life insurance plans will require you to do your homework, carefully assess your needs, and track the performance of your plan.
At the end of the day, a universal life plan could be a great insurance plan option for you. Of course, you should compare the cost and benefits of any plan against several options and with at least a few providers.
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