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Among the many types of life insurance products, the most complex may very well be universal life insurance. It is misunderstood by many life insurance customers, and therefore avoided.
Unless you absolutely love to read the minutia of how insurance products function then universal life insurance most likely requires the assistance of a trained insurance professional to fully understand. This article aims to give you a brief overview of how universal life insurance works.
Universal Life Insurance Summary
In the shortest definition possible, universal life insurance is a policy in which benefits are determined by cash value and are considered permanent. Policy holders make regular premium payments while the insurance company pays interest based upon the current cash value. As long as the current cash value continues to remain on schedule, no changes to premiums are anticipated.
However, if interest rates drop and cash value does not stay on schedule, policyholders have to increase premium payments. All of this is spelled out in the initial contract which is signed by both the insurance company and the policy holder.
Different Payment Methods for Universal Life Insurance Premiums
Three options exist for paying the premiums on a universal life insurance policy. They are single premium, fixed premium, and flexible premium.
With the single premium option a one time payment is made by the policy holder at the time the policy is established. Single premium payments are rather substantial.
The fixed premium option sets the price and frequency with which premiums are paid. It can be structured so that premiums are paid annually, quarterly, or even monthly. The amount and schedule of payments is not altered through the life of policy, although a small amount of flexibility exists within the framework.
With the flexible premium option the policy holder is allowed to make contributions at such time, and of such size, as he deems appropriate. However, if premiums and interest paid do not keep the cash value of the policy on schedule, the insurance company may require higher or more frequent payments be made in the future.
Loans and Withdrawals Made Against a Universal Life Insurance Policy
Unlike a term or whole life policy, customers who hold universal policies may take a loan against their policy or even withdraw against the cash value. If a loan is taken the principle does not need to be repaid, but the loan interest must be. Ideally, the policyholder repays the loan to maintain a high cash value upon his death. Loans are not reported to credit agencies and are not taxable.
If a withdrawal is made against a universal life policy it is also not taxed. However, it will be subject to fees and fines levied by the insurance company. In essence, making a cash withdrawal reduces the amount of earnings for the insurance company. Those reduced earnings are made up by charging the policy holder a withdrawal fees.
The 3 Common Myths of Universal Life Insurance
Be aware these 3 myths that surround this type of life insurance policy:
- An Investment: Universal life insurance policies are sometimes offered by financial planners as investment vehicles. They are touted as a form of tax-free investment to people who cannot afford to contribute to IRAs or other retirement accounts on a regular basis. However, it is a violation of federal law to sell universal life insurance policies as investments.
- Low Risk: Universal life insurance policies are sometimes advertised as low risk insurance to the policy holder. This could not be further from the truth. With a universal policy, risk resides entirely with the policy holder because he is responsible for maintaining the agreed-upon cash value. If interest rates drop to a point where cash value cannot be maintained, the policy holder must make up the difference in premium payments.
- Coverage Lapse: Finally, the biggest myth surrounding universal life insurance policies is that there can be a lapse in coverage. Again, since the policy holder is responsible for maintaining agreed-upon cash value, the insurance company will not continue coverage if the policy holder does not live up to his responsibility. If the policy holder fails in his responsibility, the insurance company is legally allowed to drop coverage.
Universal life insurance is an option for those who can afford higher premium payments. The advantage of being able to earn interest is attractive to those who have the financial means to carry such policies. But the higher risk associated with universal life insurance makes these policies a bad idea for people with limited financial means. A term or whole life policy may be a better option.
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