What Is Universal Life Insurance and Who Should Buy It?
By, Finance Writer & Licensed Insurance Agent
Universal life insurance, or adjustable life insurance, is a flexible but riskier permanent life insurance option compared to whole life. Its risk stems from the investment component, where cash value can fluctuate with market conditions.
Unlike whole life's fixed benefits and premiums, universal life offers adjustable death benefits, flexible premiums and control over cash value investments. It's preferable for consumers who use life insurance as an investment plan.
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Universal life insurance offers more flexibility in its death benefit and premiums than whole life insurance.
Adding a no-lapse guarantee rider can increase premiums, but it also offers policy protection to avoid lapsing if a payment is late or insufficient to cover costs.
A universal life policy requires monitoring to ensure the investment account meets financial goals.
How Does Universal Life Work?
Universal life insurance is a form of permanent life insurance that offers both flexibility and an opportunity for wealth building. A universal life insurance premium includes two main parts:
- Cost of Insurance (COI): This is the actual cost that covers the life insurance part of the policy. It includes factors like mortality charges, administrative fees and other related expenses. Essentially, it's the amount required to keep the death benefit in force.
- Wealth Building Component: The remaining premium goes into a cash value account. This account is invested, often in bonds or other relatively stable investment vehicles. The cash value can grow over time, and you may even be able to borrow against it or withdraw funds, subject to certain conditions.
Universal life insurance aims to provide financial security while allowing policyholders more control over certain aspects of their policy.
Key Characteristics of a Universal Life Insurance Policy
Universal life insurance stands out from other forms of permanent life insurance in the following ways:
Unlike traditional whole life insurance, universal life insurance allows you to adjust your premiums. You can pay more or less, depending on your financial situation at any given time.
Adjustable Death Benefit
You have the option to increase or decrease the death benefit, subject to approval by the insurance company. This gives you the ability to tailor the coverage to your changing needs.
Your provider invests a portion of your premium, offering the potential for growth. However, this also introduces an element of risk, as the cash value can fluctuate with market conditions.
Universal life insurance provides a clear breakdown of the costs and the performance of the investment component, allowing you to make informed decisions about your coverage.
Universal life insurance offers a blend of life insurance coverage and investment opportunity. Its flexibility in premiums and death benefits, coupled with the potential for cash value growth, makes it an attractive option for those looking to integrate life insurance into their broader financial strategy.
How Much Does Universal Life Insurance Cost?
The cost of universal life insurance is often more complex to understand than other types of life insurance, primarily due to its dual nature of providing life coverage and an investment component.
Compared to whole life insurance, universal life insurance typically offers more flexibility in premiums but can be more expensive due to the investment component. Whole life has fixed premiums and offers guaranteed cash value growth, making it more predictable but less flexible.
Term life is generally the most affordable option, providing coverage for a specified period. On the other hand, universal life offers lifelong coverage and the potential for cash value growth, usually at a higher cost.
Several factors can influence the cost of universal life insurance premiums:
The younger you are when you purchase the policy, the lower the cost.
Your overall health condition can impact the mortality charges within the policy.
Death Benefit Amount
The higher the death benefit, the higher the premium.
The cash value component's performance can affect the overall cost, as poor investment returns may require higher premiums to maintain the desired death benefit.
Additional features or riders can also influence the cost. For instance, choosing a no-lapse guarantee universal life policy will cost more than a traditional policy, while indexed universal life or variable universal life costs even more.
The ability to invest cash value can sometimes offset the increased cost of universal life insurance if you use the growth to pay premiums or lower your death benefit. For example, if the investments perform well, the accumulated cash value could cover premium payments for a period.
However, suppose the investments in your universal life insurance policy perform poorly. In that case, the cash value may not grow as expected, leading to insufficient funds to cover internal costs like mortality charges. As a result, you may need to pay higher premiums to maintain the death benefit or face limitations in the policy's flexibility, such as using the cash value to pay premiums.
Consider your financial goals, risk tolerance and the various factors that impact premiums when evaluating if universal life insurance is the right fit for your financial strategy.
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Types of Universal Life Insurance
There are several different types of universal life insurance to choose from, including non-guaranteed universal life, guaranteed universal life, indexed universal life and variable universal life. The best type of coverage for you will vary depending on your financial goals and needs.
Traditional or Non-Guaranteed Universal Life
The traditional or non-guaranteed universal life policy is the most straightforward and affordable type of universal life. You get a cash value savings account, flexible premiums and a death benefit option, but no guarantee that the policy won’t lapse if you make changes. Traditional universal life may be a good option if you want to save on your premiums. Still, you’ll have to ensure any changes made won’t cause the policy to lapse because you didn’t pay enough in premiums to keep the policy in force.
No Lapse Guaranteed Universal Life
With a no-lapse guaranteed universal life policy, you get everything included in traditional universal life, with added assurance the policy won’t lapse. You must pay a set minimum premium based on your coverage amount to ensure the policy won’t lapse. If you don’t want to monitor your policy closely but still want the features of a universal life insurance policy, this may be a better fit.
Indexed Universal Life
An indexed universal life policy allows you to grow your cash value faster by placing cash in a market index fund. This differs from traditional universal life, which typically has a modest interest rate and slowly accumulates cash value. Index universal life policies have a minimum guarantee of 0–1%, though this varies by company. You should only use this fund if you understand the stock market or are working closely with a trusted financial advisor, as the policy could lapse if it doesn’t meet target premiums or its value isn’t enough to pay costs and fees.
Variable Universal Life
Similar to index universal life, a variable universal life policy can speed up cash value growth through investments. Variable universal life policies offer more flexibility, with cash value invested into indexes, money market accounts or stocks. Investments can also be mixed, allowing faster growth, though there is typically a cap on the amount you will receive. Like index universal life, only the savviest investors should consider variable universal life, as the potential for lapsing the policy is the greatest with this universal life product.
Comparing Universal and Whole Life Insurance
Universal life insurance and whole life insurance are both types of permanent life insurance, offering lifelong coverage and a cash value component. However, they differ in flexibility, investment opportunities and cost structure, making them suitable for different financial needs and goals.
- Lifelong Coverage: Both provide coverage for the entirety of the policyholder's life, as long as you pay premiums.
- Cash Value Component: Both include a cash value that grows over time and can be borrowed against or withdrawn, subject to certain conditions.
- Death Benefit: Both offer a guaranteed death benefit to beneficiaries upon the policyholder's death.
- Flexibility: Universal life offers adjustable premiums and death benefits, allowing for more control and adaptability to changing financial situations. Whole life has fixed premiums and a guaranteed death benefit.
- Investment Opportunities: Universal life allows more control over the cash value investment, introducing the potential for higher returns and more risk. Whole life offers a guaranteed, more conservative growth rate.
- Cost: Universal life can be more complex in cost structure, with the potential for higher costs due to the investment component. Whole life offers predictable, fixed premiums.
Universal life may be suitable for consumers looking for more control over their policy and who are comfortable with investment risk. It may be a better fit for those using life insurance as part of a broader investment strategy.
Whole life can be ideal for those seeking stability and predictability in premiums and cash value growth. Those wanting a straightforward, guaranteed growth option without actively managing investments may prefer whole life coverage.
Pros and Cons of Universal Life Insurance
Universal life insurance can prove very profitable over time, but it may not be the best option for everyone. Below are some pros and cons of universal life insurance compared to whole life.
Pros of Universal Life Insurance
Universal life insurance offers long-term coverage with lower and more flexible premiums than whole life insurance. After your first payment, you'll be able to pay your premium at any time, in any amount, within certain limitations.
Cash Value Can Cover Higher Premiums
This policy’s cash value works similarly to a Roth IRA; you can put in more money in the early years and let it 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
Depending on your policy details, your insurance company may give you choices for where to invest your policy’s cash value portion. Your options may include 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.
Cons of Universal Life Insurance
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. For example, you'll need to pay premiums much higher than your cost of insurance in the first years of your policy to build up a cash value to dip into once your insurance cost exceeds your budgeted premium. If you don't, the policy could lapse, especially if it doesn't have a no-lapse guarantee clause.
Must Monitor Policy’s Cash Value
During the sales process, agents will typically provide illustrations of how your savings could grow, but these estimates are not guaranteed. Keeping track of how your cash value is doing and frequently asking your insurance company for illustrations is crucial to ensure you're getting the best possible outcome. If you don't review these illustrations and make adjustments accordingly, the cost of your policy could skyrocket.
Potential Negative Returns
While universal life 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, your provider can require you to make up the difference in the death benefit premiums or risk the policy expiring with no value. Your policy could lapse if interest rates fall below projections or insurance or administrative expenses increase. Make sure you understand the terms of your policy and your comfort level with investing in the market before committing to this type of coverage.
Conservative Interest Rates
While interest rates depend on the market, they can be relatively conservative, meaning it could take significant time for your policy to accumulate cash value.
Some plans offer a "no-lapse" guarantee, which means the policy is always in effect. However, to get this guarantee, 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.
Compare Life Insurance Rates
Ensure you’re getting the best rate for your life insurance. Compare quotes from top providers to find the most affordable life insurance coverage for your needs.
Should You Buy Universal Life Insurance?
Universal life insurance may be a good fit, depending on your life insurance needs. This type of life insurance offers flexibility but may require monitoring for lapse concerns — unless you get the no-lapse guarantee. Consider the following buyer profiles to decide if universal life is the best choice for you.
Individuals That Benefit Most from Term Life Coverage
How They Benefit
Young, Newlywed Couples
With time and health on their side, a young couple could get the best rates for universal life insurance for couples. The couple could use universal life to build cash value and, with a no-lapse guarantee, make adjustments to the death benefit or premiums as needed.
For instance, a young couple could make larger payments initially and then increase the death benefit or lower the premiums if they have children. You can use the cash value in many ways, like paying for childcare or allowing one parent to stay home while children are young.
Business owners can choose the universal life policy that best suits their goals. The savvy investor could pick an indexed universal policy or variable universal life policy to get fast cash value growth, then allow the value to pay premiums down the line. Or, they could use the cash value to finance business expenses or pay for more life insurance.
Sole Financial Providers
Sole providers keep their families financially afloat. A universal life policy's flexibility can allow premium adjustments that help families weather financial hardships while the sole financial provider is still alive.
Individuals With Significant Debts
The more debt someone has, the greater their need for life insurance. Universal life flexibility means as debts get paid down, policyholders can decrease their death benefit and save on premiums. With an index universal or variable universal policy, you can use the cash value growth to pay off debt faster.
Stay-at-home parents may not get paid, but their role in the home would be costly to replace. As needs change and the family expands, a universal life policy’s flexibility can match those needs. If the stay-at-home parent passes away, the death benefit from this policy can allow the working parent to choose to stay home or return to work. You can also use the policy's cash value for debts or expenses or to pay premiums.
Frequently Asked Questions About Universal Life
Before choosing a life insurance policy, consider which plan best suits your needs and financial goals. Check out the following common questions people have about universal life insurance to help you make the best choice.
About Mandy Sleight, Licensed Insurance Agent