Universal life insurance - sometimes shortened as UL or called "adjustable life insurance" - is one of the most flexible types of permanent life insurance, but it's also riskier and more complex than whole life. This type of coverage provides a death benefit plus a cash value component or savings, but unlike whole life, universal life insurance allows you to customize your premiums and death benefit based on your specific needs and/or current financial circumstances. For example, you can pay a higher premium when you have more money available and later change to lower payments when money is tight. In addition to this advantage, you have more control over where your cash value is being invested. Because of this, author and financial planning expert Jason Silverberg, CFP, CLU, ChFC says universal life insurance is a better vehicle for investing than whole life insurance. Learn more about this flexible option and get expert advice on how to get the most out of your investments.
Key Features of Universal Life Insurance
After your initial payment, you can pay more, less or even skip payments based on your current financial situation. Your amount of flexibility, however, may be dependent on your cash value amount, current interest rate and whether or not you have any loans or withdrawals. Typically, you can increase your premiums up to certain IRS guidelines or reduce it within specified minimum premium limits.
With a traditional whole life policy, your death benefit will stay the same as long as you don't take out a loan. With universal life, you can reduce and increase the benefit within specified plan limits; however, you may be subject to underwriting for significant increases or minimums and charges for decreases.
You can have your insurance company give your beneficiaries the face amount of your policy or the face amount plus account value. For example, if you have a $300,000 policy with a $50,000 account value, your beneficiary will receive $350,000 when you die.
Some policies have this built-in, while others offer it for an additional premium. Typically, a UL policy can lapse under certain circumstances, such as a rise in administrative expenses or interest rates falling below expectations. This option means your policy will remain in force, for a specified period of time, regardless of those circumstances. Taking out a loan, partial surrenders or not paying premiums may result in the loss of this benefit and a lapse in protection, however.
How UL Works
The amount you pay into the policy. Although premiums for universal life are adjustable after your initial payment, many companies have a minimum premium in order to cover expenses, taxes and the cost of your policy.
If the insurance company's portfolio earns more than the guaranteed interest rate, that difference is credited to your policy value.
The amount deducted from your premium payments to cover mortality, fees, commissions and any overhead. The balance goes towards the policy.
This is deducted monthly from the policy value and is used to maintain the policy. Administrative fees usually cover things such as accounting and record keeping.
These deductions are taken from the policy value every month. They cover the death benefit, any riders you purchases and supplemental benefits.
If you surrender your policy during the surrender charge period or if loans or withdrawals are made against the policy, your policy is reduced by this amount. Specific details regarding length and amount vary by plan.
Who Should Get UL Insurance?
The easy answer to this question is anyone who wants a permanent life insurance policy. Deciding between whole life or universal life is really a personal preference based on goals and income, but generally speaking, UL might be a better option if you're interested in whole life, but also:
- Want more hands on control of the process and financial side
- Are more savvy and comfortable with investments
- Have a high income and can pay larger premiums up front to build cash value (or cover a higher cost of insurance when you're older)
- Are more interested in estate planning
Types of Premiums
With universal life insurance, you can choose to pay your premiums one of the following ways:
Pros and Cons of Universal Life Insurance
Universal life insurance can prove very profitable over time, but it is not for the risk averse. Below are some of the pros and cons of universal life insurance compared to whole life.
Universal life insurance offers long-term coverage, with premiums that are lower and more flexible than whole life insurance premiums. After your first payment, you'll have ability to pay your premium at any time, in any amount, within certain limitations.
Cash value can be used to cover higher premiums
UL's cash value works similarly to a Roth IRA - you can put in more in the early years and let that money accumulate. If you pay higher premiums early on in your policy, you'll likely build up enough cash value to supplement increased premiums as you age.
Control over investments
Your insurance company will give you choices for where to invest your cash value portion. This might be an equity index strategy, a one-year term deposit or a general interest account.
No cap on returns
Universal life insurance policies use a money market-type investment that pays a market rate of return. If the market is strong, universal life insurance policies may yield much higher returns than fixed-rate whole life insurance policies. However, as with most investments, returns are not guaranteed.
While flexible premiums are a major benefit, they can also be a con. You can choose how much to pay based on your current financial situation, but the actual cost of insurance will continue to increase as you age. This means you'll need to pay premiums that are much higher than your cost of insurance in the first years of your policy in order to build up a cash value to dip into once your cost of insurance exceeds your budgeted premium. If you don't, it can mean trouble. According to a The Wall Street Journal, some consumers have paid $30,000 annually just to avoid losing a $280,000 policy.
You'll need to monitor your cash value
This is not the type of policy where you can simply pay the premium and go. During the sales process, agents will typically provide illustrations of how your savings could build, but these estimates are not guaranteed. You'll need to keep track of how your cash value is doing and frequently ask your insurance company for illustrations to make sure you're getting the best possible outcome. If you don't review the illustrations and make adjustments, the cost of your policy could skyrocket.
Potential negative returns
While UL is a form of permanent life insurance, the policy will stay in effect only as long as the cash value is enough to cover the cost of insurance (unless you have a no-lapse guarantee). This means the market could work against you, and some policies allow the insurance company to dip into your cash value to recoup losses. Even worse, when your cash value hits $0, they can require you to make up the difference in the death benefit premiums or risk the policy expiring with no value. Or if interest rates fall below projections or insurance or administrative expenses increase, your policy could lapse. Make sure you understand both the terms of your policy and your comfort level with investing in the market before committing.
Conservative interest rates
While interest rates are dependent on the market, they're usually relatively conservative.
Some plans offer a "no-lapse" guarantee, which means the policy is always in effect. To get this guarantee, however, a company may require you to make payments on time, even going so far as to cancel policies if you pay just one day late.
Universal Life Insurance Shopping Tips
A 2015 study showed that many consumers are intimidated by the process of purchasing any type of life insurance. Reasons included beliefs that life insurance was too expensive, not knowing how much coverage they needed or not knowing what type of plan to get. Evaluating your expenses, doing research and comparison shopping can help make the process less overwhelming. When shopping for a UL policy, try to following tips:
Some insurance companies recommend purchasing a policy worth 15 times your annual income. Other financial advisors recommend a policy worth 3.5 times your income plus outstanding debts. To determine how much coverage you need, try working with a financial planner instead of an insurance agent. Because financial planners don't have a direct connection to a particular company, you're more likely to get unbiased advice from them. Although premiums for universal life insurance can be smaller than those for whole life insurance, that doesn't mean they are cheap, so you want to ensure that they will work as investments for you. Life insurance calculators are also a good place to start when trying to figure out how much coverage you need. Try MoneyGeek's calculator so you can begin your search with a target number in mind.
People who choose universal life insurance typically use it as an investment tool, most often for estate planning. However, universal life insurance works best as an investment tool when you fine-tune it based on your risk tolerance and financial goals.
Silverberg explains the difference between fixed, variable and indexed universal life policies, all of which are geared toward different investors. First, fixed universal life maintains a specified interest rate. "These rates can change," Silverberg says, "but your principal is always protected." Variable universal life uses subaccounts, which function similar to mutual funds, to invest cash value in a combination of stock- or bond-based funds that match your risk tolerance. Indexed universal life is somewhat of a cross between the other two. Silverberg explains, "While the cash values are not actually invested in the markets, they are credited with an interest rate that tracks a specified index. The rates usually have a floor and a ceiling, protecting the investment from a major market downturn but giving up some of the upside as well."
While it may sound ideal to leave your beneficiary with a million dollars or more or to push the boundaries with your investments, you want to make sure you're not overpaying for a UL policy.
Remember that life insurance is primarily about the death benefit, not accumulation
"Life insurance is merely a vehicle by which you pay a premium and, in the event of your death, the life insurance company will pay out a stated lump sum to your beneficiary,"Richard E. Reyes, CFP. Reyes describes life insurance as "a very powerful and useful tool" for a person's surviving beneficiaries.
Don't make it your only investment
Reyes continues: "Life insurance can also be a very useful tool as an investment vehicle, but it will never have the same return over time as a properly allocated portfolio...due to fees and cost of insurance."
Consider your income level before investing
According to Reyes, people with higher incomes benefit from universal life insurance because they can use it to create a plan that shifts assets away from taxable accounts into tax-free accounts inside of permanent life insurance. "Over time, when you include taxes in your calculation, if properly structured, it is a good deal; however, it is not an either/or plan — it's in conjunction with your other assets, allowing you flexibility for future taxes," he says.
Consider a rider to the policy
According to Jason Silverberg a no-lapse or secondary guarantee can be ideal. "Because of the flexibility of these policies, the insurance company doesn't contractually know if you will pay them the premiums they need to be able to pay out the death benefit," he says. As a result, companies have the right to come back and ask you for more money later to retain your policy benefits. "This rider protects your policy from the insurance company raising your rates,"Silverberg.
Canceling Your Policy Early
Life circumstances are unpredictable, and even the most carefully chosen policy could eventually become more of a financial burden than a help. You may not have considered canceling your policy before, but there are times when canceling may be in your best interest. Here are three common situations when you should consider canceling:
- You'll lose all of your death benefits
- You'll get your accumulated policy value, minus surrender charges and any loan interest
- Once a UL policy is surrendered, it cannot be restored
- If you cancel during the surrender charge period, which may be the first 10-15 years, you may be subject to significant surrender charges that will come out of your cash value
- Any gains you received through your policy will be taxed as income
Alternatives When Canceling Isn't Ideal
As you grow older, getting covered by a new policy with affordable premiums becomes increasingly difficult so before terminating, exhaust all options with your current coverage. According to The Huffington Post, the National Council of Life Insurance Legislators created The Life Insurance Consumer Disclosure Act in 2010, which requires companies to give written notice of alternatives to lapsing or surrendering policies. If canceling your policy is something you're seriously considering, talk to your insurance company for more information. Some of the alternatives your company may discuss with you could include:
If you're young, healthy and only need short-term coverage, a term life policy might be a better, more affordable option.
If you're not happy with the current terms of your plan - perhaps because you feel your death benefit is not high enough - contact your insurance company to see what riders are available to enhance coverage.
If your premiums are too high and you have already paid off most of your beneficiaries' expenses, consider decreasing your death benefit in exchange for lower monthly premiums.
If you're 60 years or older, the following alternatives are worth considering before letting your UL policy lapse:
With accelerated death benefits, a terminally ill policy holder can receive cash advances against the policy's death benefit.
You can give away your universal life insurance policy if you no longer need the benefits. Once the policy has been transferred, the new policy holder will be responsible for premium payments.
Much like any personal property, UL can be sold through a life settlement. If you're older than 70, you can sell your UL policy to a third party for more than the surrender value but less than the death benefit. You'll receive the cash payment and the buyer will assume all future premium payments. The buyer will also receive the death benefits when you die.
Through a life insurance conversion program, you can sell your policy to a third party in exchange for monthly payments towards long-term care services.