Universal life insurance provides a distinct alternative to traditional whole life policies, offering a degree of flexibility that can be appealing for those seeking coverage with an investment component.
What is Universal Life Insurance?
Unlike whole life insurance, universal life insurance allows policyholders to adjust their premiums and death benefits as their circumstances change. This adaptability is a core feature of universal life policies.
Universal life insurance policies contain a cash value component, similar to whole life. However, in this case, the cash value is typically tied to interest rates, stock market indexes, or subaccounts that you choose. This offers the potential for greater growth but also requires careful monitoring to ensure the policy remains adequately funded.
How Does Universal Life Insurance Work?
As premium payments are made, a portion of the payments accumulates within a cash value component that grows over time. This cash value growth depends on the investment choices you make (in some policy types) or the insurer’s performance (in other variations).
This cash value can be used to cover premiums, take out loans, or even supplement retirement income. When the policyholder passes away, beneficiaries receive a death benefit, which is generally tax-free. However, any remaining cash value usually is not paid out to the beneficiaries.
Types of Universal Life Insurance
There are three main types of universal life insurance available:
- Indexed Universal Life Insurance: Investments are linked to a stock market index, such as the S&P 500. These investments usually come with limits on both gains and losses.
- Variable Universal Life Insurance: Gives policyholders the ability to manage sub-accounts where money is invested in stocks and bonds. Investing in this way means that the cash value of the policy could decrease if your investments perform poorly.
- Guaranteed Universal Life Insurance: Offers fixed death benefits and premiums. This type of plan also doesn’t earn as much cash value as other types of universal life policies. You will select an age when the coverage expires (often over age 90). If even one payment is missed, the policy could lapse. The cost of these plans tends to be lower.
Choosing the right type of life insurance will depend on your budget, your comfort in managing investments, and your coverage needs.
Benefits and Drawbacks of Universal Life Insurance
It’s important to consider both the advantages and disadvantages of universal life insurance:
Benefits:
- Coverage continues, unlike term life policies, which expire after a set period.
- Offers a cash value component that can be accessed for policy loans or used to pay premiums.
- Premium payments are flexible, allowing adjustments as income changes, such as in retirement.
- Death benefits can also be adjusted in line with changing needs.
- Cash value grows on a tax-deferred basis, and death benefits are usually tax-free.
Drawbacks:
- More expensive premiums than term life insurance policies.
- Cash value growth is not guaranteed.
- Fees can be high, especially for variable universal life insurance products.
- These policies can be more complex, and require that you invest and track the money you pay into the policy.
Universal Life Insurance FAQs
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What is universal life insurance? It is a permanent life insurance policy that offers flexibility in adjusting premiums and death benefits. It offers a savings element where cash value growth is tied to the performance of interest rates, stock indexes, or subaccounts.
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What are the disadvantages of universal life insurance? The primary disadvantage is that it can be more expensive than term life insurance. In addition, because the funds are tied to the market, the cash value component is not guaranteed. If the underlying investments don’t perform as expected, the policy may lapse.
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How much does universal life insurance cost? For a $250,000 universal life policy, a healthy, non-smoking 40-year-old male can expect to pay, on average, between $103 and $150 per month. The average for a similarly aged female is between $83 and $130 per month.
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Is universal life insurance worth it? It may be a good choice if you want flexibility and the capacity to use the policy for wealth generation. A term life policy may be a more appropriate choice if you want a more economical plan that only protects your family during your high-earning years.
