Universal life insurance is a policy that allows an insured person to maintain consistent coverage throughout their entire lifetime. Also referred to as a cash value policy, it allows you to build savings as well as have something to pass onto your beneficiaries regardless of how long you live.
Many people opt for this type of insurance due to the ability to pay lower, more flexible premiums while enjoying the monetary asset building properties. However, maintaining and accessing the policy benefits may not be as easy as initially thought. In this article we will explain how a universal policy can work for you.
How Does Universal Life Insurance Work?
Universal life insurance works by initiating a policy where the premiums are divided into two separate installments. The first one goes towards the coverage that will payout at the end of the policy and the rest is put into a savings account as a financial investment.
As the original policy owner, the amount of premiums that you are responsible for paying each month is preset according to a range that corresponds with your overall coverage amount. Minimum payments are then determined by several variables including your death benefit, the true insurance costs, and any necessary administrative or maintenance fees.
Funds in excess of premium amounts due are allocated towards the cash value of your policy, which accumulates based on the insurer’s annual interest rate. Opting for maximum monthly payments allows the cash portion to grow quickly, however it is important to note that premiums also escalate over time as the coverage matures.
Types of Universal Life Insurance Policies
Choices for this type of insurance policy are offered in three main segments, with each providing alternative coverage based on investment type, premium amounts, as well as other factors.
- Guaranteed Universal Life Insurance – This policy option allows you to maintain coverage over the course of your lifetime while keeping premium payments identical throughout. Due to a fixed interest rate at the policy’s onset, monthly amounts won’t increase or decrease, however, this type of insurance provides a much lower cash value threshold compared to other options.
- Indexed Universal Life Insurance – Being tied to the performance of various market indexes, this type of policy has a cash value that fluctuates relative to the interest rates of the index. Premiums are not considered preset under these policies due to market influence across multiple factors, which may make it a riskier investment for some.
- Variable Universal Life Insurance – Variable policies are those which provide a fluctuating monthly premium, however they also provide an investment vehicle for your cash value portion in the form of a mutual fund. Returns can do well based on market rates or performances as well as give you a range of diversification. However, being aware of the fees associated with fund management will identify exactly where your funds are going.
Whole Life vs Universal Life Insurance
Whole life insurance is similar to universal life insurance in a variety of ways such as cash value that can be borrowed as well as permanent coverage for the term’s duration. However, with whole life the death benefit is locked-in until the maturation date. The same conditions apply to the monthly premiums paid as well.
Universal life insurance encourages flexibility in terms when it comes to how much money in monthly premiums you are able to cover, in addition to the selection or changes made to preferred death benefit amounts. The varying interest rates in a universal life insurance policy also have the potential to accumulate faster returns in the form of its cash value portion.
| Whole Life Insurance | Universal Life Insurance |
|---|---|
| Permanent policy | Permanent policy |
| Cash value during lifetime | Cash value limited |
| Fixed interest rates | Variable or fixed interest rates |
What are the Benefits of Universal Life Insurance?
Universal life has several benefits that may be of interest to policyholders. They include payment flexibility, cash value accumulation, and an option to reselect the death benefit amount. Depending on the type of policy that is chosen, the earnings may be designated as FIFO or first in first out, which allows you a bigger share of the cash value due to the accounting method in which payments are calculated.
In addition to receiving more funds, those with a universal life policy may exercise the option to borrow a portion of the cash value before it expires while avoiding tax ramifications. Current IRS guidelines only require that taxes be paid based on interest accumulated versus the loan proceeds in most situations, leaving more funds for expenditures versus paying penalties or fees.
What are the Disadvantages of Universal Life Insurance?
While there are several benefits to having a universal policy, this type of coverage may also pose some disadvantages as well. One such downside is that only a portion of your monthly premiums will qualify for cash value accumulation. Due to this factor, policy payments are often far more expensive than with other kinds of coverage.
Although the premiums on universal life are considered flexible, they also come with a hefty round of fees, which can be an additional strain on your return on investment when contending with fluctuating interest rates due to market downturns.
Should You Get It?
A universal life insurance policy is a great investment for those looking to obtain coverage that lasts an entire lifetime without compromising your monthly budget. However, if you are seeking to obtain the highest possible cash value for your beneficiaries upon an unexpected death, then an alternative option may be an optimal solution.
Conclusion
Life insurance coverage is a necessity that most people should have at some point in their lives. With many options to choose from while navigating the maze of intricacies that are tied to each policy, it’s best to speak with several advisors to make the best investment for your own family.
