Universal life insurance (UL) is a policy that offers lifelong coverage to age 121 and builds up cash value as long as premiums are paid. Often referred to as adjustable life insurance because the premiums and death benefits are flexible, while allowing more options on how the cash value is invested.
Universal life insurance (UL) is a permanent life policy, sometimes referred to as a term/whole life hybrid. It combines elements of a term life policy with cash value option of whole life. A UL policy allows you to build savings while providing life insurance to your loved ones as well. Unlike a term policy which has an expiration date, a UL policy lasts forever.
Universal life insurance differs from whole life because of the flexible premiums and death benefits. In a UL policy you can increase or decrease the premiums or death benefit. If decreasing the premium, there must be enough cash value to cover the cost of insurance and if you increase the death benefit, evidence of insurability will have to be shown again.
How Does Universal Life Insurance Work?
When you purchase a universal life insurance policy, your first step will be choosing your death benefit. The premium is based on the amount of death protection you choose. A part of your premium pays for the cost of insurance (COI) and any fees, while the remaining premium is invested into the cash value account. The way interest is calculated all depends on which type of universal life policy is chosen.
They are 4 types or variations of universal life insurance. Each of these policies are similar but have one distinct difference, and that is how interest is calculated to the cash value.
4 Types of Universal Life Insurance
Traditional Universal Life Insurance
Traditional universal life policies were the first of the universal life portfolio. These products were designed to be a low-cost option compared to whole life. The policies cash value interest was based on the overall performance of the insurance carriers’ portfolio and the interest is declared each year on your anniversary date.
These policies do have a minimum guaranteed rate, but the premiums are usually based off the non-guaranteed interest rate. The major downfall to these policies is that the premium is not guaranteed. If the cash value doesn’t perform like the illustration that was shown during the time of sell, this could lead to a premium increase down the road.
It’s important if you own a traditional universal life policy to request in-force illustrations so that any problems down the road can be alleviated.
Guaranteed Universal Life Insurance
The second type of universal life policy, and probably the most popular is guaranteed universal life insurance. These policies are the most like a whole life policy in that the premium is guaranteed for life.
These policies were designed because consumers like the lower premiums of a traditional universal life policy but wanted the guarantees that a whole life policy offered. Guaranteed UL do build up cash value but are concentrated more on keeping the premiums as low as possible. In other words, don’t buy a guaranteed UL for the cash value build up.
Indexed Universal Life Insurance
Indexed universal life insurance has been gaining some traction the last few years because of its attractive investment options. These policies also don’t usually come with a guaranteed premium, except for few life insurance carriers. The premium remaining level is solely determined by how the cash value/investment performs.
The way interest is credited in an indexed universal life policy is what makes it so unique. You have an option to be invested in the market with no chance of losing money. Sounds great doesn’t it.
How is that possible?
All indexed universal life policies have options to be invested into stock market indexes, such as the S&P 500 or Nasdaq. They all come with guaranteed floor of usually 0%, some with a floor of 1%. This means that if the index you are invested has a negative return for your policy year, the worst your account could earn is 0%.
The downside to these policies, if you can call it that, is that your interest gained is capped. Caps on most indexed universal life policies are around 12% annually depending on the company. This means that the interest you can earn falls between 0% (the floor) and 12% (the cap), anything above 12% the company keeps.
These policies can be used to supplement retirement income, pay for college tuition, or as a savings account because of the tax advantages associated with the withdrawal of money from life insurance policies.
Be wary, there are fees associated with these policies that need to be fully understood before purchasing an indexed universal life policy.
Variable Universal Life Insurance
Variable universal life insurance is the most complicated universal life policy offered. This is solely based on the unknown of how the cash value is going to perform, which could affect the premium in both a positive and negative way.
The cash value in a variable life policy is invested in sub accounts which mirror mutual funds. Being similar to a mutual fund means that the policy cash value has ups and downs based on the market. There is no cap or floor like the indexed universal life policy. You will feel all the gains, but the losses as well.
These policies require regular attention to make sure the investments are where they need to be and to ensure the policy remains in effect without having the premium increase. Premiums are never guaranteed with variable life policies, which could lead to disaster if not properly funded or the investment doesn’t perform as illustrated.
We would say these types of universal life policies are designed more for the savvy investor, not someone looking for a simple life insurance policy.
Our Two Cents
There you have it, what universal life insurance is, what types there are, and how each accumulates interest into the cash value. But how do you know if it’s a good fit for you and which type is best. You will always want to work with an experienced life insurance agent.
They will be able to explain in detail the pros and cons of each policy and recommend which would fit your situation best. Make sure to ask all questions and do some research on your own. With the internet you can find both pros and cons of universal life which will help you make an informed decision. If you have any questions or comments please don’t hesitate to give us a call.