Universal life insurance is a type of permanent life insurance that provides lifetime coverage as long as you pay your premiums. Like other permanent life insurance, it has a cash value element that can be used for different purposes. Universal life differs from whole life in that it allows you to lower or raise your premiums within certain limits and offers more flexibility.
How Does Universal Life Insurance Work?
Premiums for universal life insurance have two components – the cost of insurance (COI) amount and the cash value or savings component. The COI is the minimum premium payment required to keep the policy in effect. This amount can vary depending on the age and insurability of the policyholder and the insured risk amount. Premiums collected in excess of the COI amount accumulate within the cash value portion of the policy. As the insured ages, the cost of the insurance will increase. The accumulated cash value can cover the increases if the amount is sufficient.
What Are the Benefits of Universal Life Insurance?
Pros of a universal life insurance policy include:
- Flexibility: These policies typically have flexible premiums within limits. Policyholders can pay more than the COI; in which case the excess premium amount is added to the cash value and accumulates interest. If enough cash value accumulates, policyholders may lower or skip premium payments without the policy lapsing. In some cases, policyholders may be able to increase the amount of their death benefits (although a medical exam may be required) or lower their death benefits to lower their premiums.
- Cash value growth potential: Like all permanent life insurance, universal life policies can accumulate cash value. These funds earn interest based on whichever is greater – the policy’s minimum interest rate or the current market. As cash value accumulates, policyholders may use part of it in the form of withdrawals or loans.
- Low-interest loans: Policyholders may borrow against the cash value of a universal life insurance policy without tax implications. These loans are made at interest rates often lower than rates available for personal loans, with no credit check. However, outstanding loans at the time of death will reduce the death benefit by the amount that is outstanding.
What Are the Disadvantages of a Universal Life Policy?
Although it offers several important benefits, universal life insurance has certain disadvantages. One is that the cash value of the policy is lost when the policyholder dies. The beneficiaries only receive the death benefit, and the insurance company keeps the cash value. Some withdrawals are taxable. Returns on cash value are not guaranteed, as they are with whole-life policies. In addition, with the flexibility to lower premiums and make withdrawals in times of need, you run the risk of your cash value falling to zero and your premiums not covering the cost of insurance, in which case your policy could lapse.
If you are shopping for life insurance, you may want to compare term life, whole life, and universal life policies. Our friendly agent is happy to review the different options with you and help you obtain a life insurance policy that meets your needs.