What is Universal Life Insurance?

What is Universal Life Insurance?

Universal life insurance is a form of permanent life insurance that, like other permanent policies, contains a cash value component and provides lifetime coverage as long as you pay your premiums. Unlike whole life insurance, universal life allows you to increase or decrease your premiums within specified restrictions, and it may be less expensive than whole life coverage. However, if your assets underperform or you underpay for an extended period of time, your death benefit may be reduced or your insurance will terminate.

Key Takeaways

·       Universal life insurance is a type of permanent life insurance that includes investment savings as well as adjustable premiums and death benefits.

·       Unlike term life insurance, a UL policy can build cash value.

·       The cash value earns an interest rate determined by the insurer, which can fluctuate regularly, however there is often a minimum rate that the insurance can earn.

·       If the investments underperform, your cash worth may decline, and your premiums may eventually rise.

·       Policyholders who borrow against the accrued cash value of their UL insurance are not subject to taxes, however some withdrawals may be.

How Does Universal Life Insurance Work

UL insurance offers greater flexibility than whole life insurance. Policyholders can change their premiums and death benefits. UL insurance premiums include two components: the cost of insurance (COI) and the cash value.

As the name indicates, the COI is the minimum premium payment necessary to keep the insurance valid. It comprises of numerous goods combined into a single payment. COI covers payments for mortality, policy administration, and other directly related expenses for keeping the life insurance policy in force. COI varies each policy, depending on the policyholder's age, insurability, and insured risk amount.

Collected premiums in excess of the cost of UL insurance grow in the cash value section of the policy. The cost of insurance will rise as the insured matures. However, if adequate, the cumulative cash value will cover any increases in the COI.

Advantages and Disadvantages of Universal Life Insurance

Pros:

Flexible premiums.

Unlike whole life insurance plans, which have set premiums for the duration of the policy, UL insurance products often have adjustable rates—within certain restrictions. Policyholders can make payments that exceed the COI. The extra premium is added to the cash value and accrues interest. Alternatively, if there is adequate cash value, policyholders can reduce or omit payments without risking a policy lapse.

Possible Flexible Death Benefits

Your insurance may allow you to enhance the amount of your death benefit, albeit this may necessitate a medical examination. You may also be able to reduce your death benefit, lowering your premiums.

Potential Cash Value Growth

A UL insurance policy, like all other types of permanent life insurance, can accrue monetary value in the form of savings. The cash value receives interest depending on either the current market or the policy's minimum interest rate, whichever is higher. As it increases, policyholders can withdraw a portion of the cash value in the form of partial withdrawals or loans.

Allows Policy Loans.

Universal life policyholders can borrow against their accrued cash value with no tax consequences. These loans frequently have cheaper interest rates than a personal loan and do not need a credit check. However, unpaid debts will lower the death benefit by the amount owed.

Cons:

Risk of high payment requirements or policy lapse.

While the opportunity to cut your premiums and make withdrawals in times of need contributes to universal life's flexibility, you must keep a close eye on your account. If your cash value reaches zero and your premiums do not cover the cost of insurance, your policy will lapse.

Returns are not guaranteed.

If interest rates fall, your cash worth may perform poorly. Unlike whole life insurance, universal life cash value does not pay a guaranteed rate. However, most UL plans include a minimum rate, which limits your losses.

Certain Withdrawals Are Taxable.

When UL policyholders remove portion of their cash value, it will be taxed. In general, life insurance is taxed on a first-in, first-out (FIFO) basis, which means that the policy owner receives their investment in the contract first, followed by any policy gains.

 However, if you remove more than you put into the policy, the amount would be taxed.

Cash value lost at the policyholder's death.

When a policyholder dies, the insurance company retains the account's cash worth. Your beneficiaries will only get the death benefit, as the policyholder may only utilize the cash value while alive.

What is the difference between universal life insurance, term life insurance, and whole life insurance?

Universal life insurance is a type of permanent life insurance that allows policyholders to pay premiums in different ways, includes a cash savings component, and provides a death benefit.

Universal life insurance allows you to borrow against or pay out the savings component, which accumulates tax-deferred during your lifetime. Term life insurance offers coverage for a certain number of years, often 20 or 30, and then expires. Term life insurance is often less expensive, with lower premiums, but there is no cash component to borrow from or cash in, and there is no death payout if you die after the term expires.

Whole life insurance is a type of permanent life insurance that includes a cash value savings component. One significant distinction between universal life and whole life insurance is that the UL interest rate is not guaranteed. It is determined by the insurer and may vary regularly. Whole life insurance rates are constant for the duration of the policy, whereas universal life premiums change.

Whole life insurance guarantees cash value and death payments, whereas universal life does not.

What is the main disadvantages of universal life insurance?

A significant drawback is that you must keep a watch on the monetary value. If you don't, the insurance may become underfunded, requiring you to make significant payments to keep it current. Furthermore, there is a danger that when interest rates fall, your cash worth may not increase as much as you had intended. However, there is usually a minimum interest rate, so you are partially protected.

Which is preferable: entire life insurance or universal life insurance?

Whole life and universal life are both types of permanent life insurance that include a cash value savings component from which policyholders can borrow or cash out.

What's what's the difference between universal and whole life insurance?

Whole life insurance is more stable since the death benefit will never decrease if you pay the fixed monthly payments. Universal life insurance provides more freedom, but the death benefit is not guaranteed. With universal life, you may increase or reduce your premiums, and some policies let you to alter your death benefit.

Can I cash out of my universal life insurance policy?

Yes, you can sell your universal life insurance policy or liquidate the cash value component and cancel it; but, if the surrender term has not expired, you may be required to pay a surrender charge.

The Bottom line

Universal life insurance combines permanent life insurance with investment savings, lending alternatives, and adjustable premiums. UL insurance let you can raise or cut your premiums within certain restrictions, making them less expensive than whole life coverage. You only need to ensure that your cash value does not fall so low that you are forced to pay exorbitant premiums or the policy expires.

Policyholders who borrow against the cash value of their UL insurance policy face no tax repercussions; nevertheless, interest will be levied on the loan amount, and any unpaid amounts may be deducted from the death benefit. Policyholders should also be cautious when withdrawing from the insurance, as some may be taxed.