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What Is Universal Life Insurance?
By Kat Tretina MONEY RESEARCH COLLECTIVE
If you’re like most people, you don’t have enough life insurance coverage to protect your loved ones. In fact, LIMRA reported that 102 million Americans are uninsured or underinsured.
Among the most common reasons people cite for lacking coverage is that they aren’t sure which type of life insurance to buy. While term and whole life policies are the most common, they aren’t the only options.
Another type of life insurance to consider is universal life insurance. It’s a form of permanent coverage that builds cash value, but it offers more flexibility than whole life insurance. However, it can be expensive, and it’s not for everyone.
What is Universal Life Insurance?
Pros and Cons of Universal Life Insurance
Types of Universal Life Insurance
Is Universal Life Insurance a Good Idea?
Universal Life insurance FAQs
Summary of the Guide to Universal Life Insurance
What Is Universal Life Insurance?
Life insurance can be temporary, or it can be permanent. Temporary life insurance, more commonly known as term life coverage, lasts for a specific period of time, such as 10, 20, or 30 years. Once the term expires, so does the coverage. If you pass away after the term expires, your beneficiaries don’t receive a death benefit.
By contrast, permanent life insurance covers you for your entire life. Universal life insurance is one type of permanent coverage. It’s similar to whole life insurance in that it offers lifelong protection and builds cash value — the money that builds up inside a universal life insurance policy. (That cash value differs from the death benefit, which is the amount of money that’s paid out to your beneficiaries if you die while the policy is in effect.)
Compared to whole life coverage, universal life policies offer more flexibility with your premiums and death benefit.
How does universal life insurance work?
With a universal life insurance policy, you make premium payments that go into two different buckets. One bucket is for the death benefit, and the other is for the cash value. The cash value account grows at a money market rate of interest, which is set by the insurance company.
Universal life insurance policies also allow you to adjust your death benefit as your needs change. For example, if you realize you need a larger death benefit, you can increase your coverage amount (provided you pass a medical exam).
Your death benefit remains in effect for as long as you pay your premiums. And if the policy’s cash value builds enough, you can use the cash value to pay your premiums. Just keep in mind that if your cash value runs out and you don’t make a separate payment, your policy will lapse and you’ll lose coverage.
Universal life insurance vs. whole life insurance
Whole life insurance is another form of permanent life insurance. So how does universal life insurance compare to whole life coverage?
The biggest difference between universal life and whole life insurance is that universal life offers more flexibility. With universal life, you can change your premiums and death benefit as your needs change.
With whole life insurance, your premiums are fixed when you first purchase the policy. Unlike universal life insurance policies where premiums can fluctuate, whole life insurance policies usually have predictable premiums.
However, that predictability comes at a cost. In general, whole life insurance is much more expensive than universal life coverage.
Pros and Cons of Universal Life Insurance
Before purchasing a universal life insurance policy, weigh the pros and cons:
- Long-term protection: Unlike term life insurance which lasts for only a certain period, universal life insurance (as a type of permanent life insurance) can provide coverage for your entire life.
- Flexibility: With whole life coverage, your benefits and premiums are fixed. But with universal life insurance, you can make adjustments to your policy as your needs and budget change.
- Lower cost than other permanent insurance options: Whole life insurance can be prohibitively expensive. For example, a whole life policy for a healthy 25-year-old woman would cost between $830 and $930 per month. Universal life coverage is comparatively cheaper; a policy with the same death benefit amount would cost around $200 per month.
- Premiums can change: Depending on the coverage you choose and the insurer, your premiums on a universal life insurance policy can change. You may receive notices that your premiums will increase for the upcoming year, making it more difficult to budget for the future and your long-term goals.
- Expensive: Although universal life insurance is less expensive than whole life coverage, it is still much more expensive than term life coverage. For example, a healthy 25-year-old woman could purchase $500,000 of term life coverage with a 20-year term for around $20 per month. Not everyone needs permanent life insurance, so a term life policy may be a cost-effective option.
- Management: Because universal life policies' costs and premiums can vary over time, they require more management than other life insurance policies. If you don't regularly check on your policy and its cash value, you risk losing coverage because your policy may lapse.
How much does universal life insurance cost?
Universal life insurance is more expensive than term life insurance, but less expensive than whole life coverage. Generally, you can purchase $250,000 of universal life coverage for as little as $50 or so per month.
To give you an idea of cost, we requested quotes from three leading insurance companies and used those quotes to calculate an average monthly premium. The rates below are for $500,000 in coverage for individuals in excellent health who live in Miami, Florida.
| Average Monthly Premiums for Universal Life Insurance | |||||
| 25 Years Old | 35 Years Old | 45 Years Old | 55 Years Old | 65 Years Old | |
| Female | $197 | $288 | $422 | $648 | $1,102 |
| Male | $228 | $326 | $482 | $766 | $1,331 |
Types of Universal Life Insurance
Within universal life insurance, there are three main sub-categories:
- Guaranteed universal life
- Indexed universal life
- Variable universal life
All three types have a death benefit and cash value. But how that cash value is handled differs:
Guaranteed universal life insurance
Guaranteed universal life policies have fixed premiums and a guaranteed death benefit. Guaranteed universal policies will pay a set death benefit, regardless of market changes.
Further, the cash value in a guaranteed universal life policy doesn’t fluctuate with market changes. That means the cash value in guaranteed universal life policies is usually minimal, which could be a drawback if you want to have the option of tapping into your cash value in retirement.
Indexed universal life insurance
While all universal life policies have the potential to accumulate cash value, indexed universal life policies also have an investment portion. Instead of paying a fixed interest rate, you can invest the cash value of your policy. The cash value’s performance is tied to a stock market index, such as the S&P 500 or Dow Jones Industrial Average (DJIA).
Indexed universal life policies usually have floors, meaning your account is protected from a certain level of market loss.
Variable universal life insurance
Like indexed universal life policies, variable universal life policies have an investment component. However, variable universal life policies have separately managed sub-accounts, and each sub-account can be invested in portfolios of stocks, bonds and other securities.
Variable universal life insurance policies offer the potential for growth, but each sub-account will charge portfolio management fees.
Is Universal Life Insurance a Good Idea?
Universal life insurance can be a good option for those who want the lifetime coverage of permanent life insurance and the flexibility afforded by loans and cash withdrawals from the policy. You can also adjust your coverage and premiums over time, allowing you to adapt to life changes.
However, these policies are not for the naive. Universal life insurance is best for people that are more hands-on with their finances rather than those looking for a set-it-and-forget-it solution. You have to regularly check on your policy to see if your cash value can adequately cover your premiums, and there can be fluctuations in premiums too.
Universal Life Insurance FAQs
What is the cash value of universal life insurance?
Permanent life insurance policies can build cash value. When you pay your premiums, a portion of the premium goes toward the policy's cash value. Depending on the type of universal life insurance you choose, the cash value can grow at a fixed rate of interest, or you can invest it to potentially grow it even more.
What happens when a universal life insurance policy reaches its maturity date?
Some universal life insurance policies have maturity dates, which can range from 85 to 121 years of age. Once the policy reaches the maturity date, the cash value and death benefit of the policy is paid out, and the policy ends.
Who should buy universal life insurance?
Universal life insurance could be useful for those who want permanent life insurance, but want lower premiums than whole life policies. Universal life insurance is more flexible than whole life coverage, and is generally less expensive.
What can I do with the cash value of my universal life insurance policy?
With cash value life insurance, you can use your universal life insurance policy's cash value to do the following:
- Pay premiums: You can use the cash value of your universal life insurance policy to pay premiums. This could be helpful if you experience financial hardship and are unable to make premium payments.
- Take out loans: You can borrow against the cash value of your universal life insurance policy to pay for home repairs or other major expenses. However, policy loans must be repaid with interest.
- Withdraw money: You can make withdrawals from the cash value of your universal life insurance policy. However, withdrawals will reduce the death benefit of the policy, and may be taxable as income.
Summary of the Guide to Universal Life Insurance
By understanding the different life insurance products available, you can choose the best coverage for your family.
In our guide to universal life insurance, we’ve covered the basics of what universal life insurance is, the different types of policies available and how cash value accumulates in a policy.
Universal life insurance may be a good option if you’re looking for permanent life insurance but want flexible premiums and coverage. That said, if you want a simple, basic policy to provide for your family if you pass away, a term life insurance may be a better — and cheaper — option. You can shop around and get life insurance quotes from the top life insurers to help you make an informed decision.
