Universal life insurance: 7 tips to help you choose a policy

Looking for a universal life insurance policy to help protect your family and leave a legacy?

Sometimes called permanent life insurance, universal life insurance gives you a few more options than other types of life insurance.

But there are a lot of variables to consider when you’re trying to choose a plan.

In this article, these 7 tips will help you better understand your options:

1. What is universal life insurance?
2. How universal life insurance premiums work
3. Understanding the cash value of universal life insurance
4. Universal life insurance death benefit: How it works
5. The pros & cons of universal life insurance
6. 3 types of universal life insurance policies
7. Who should get universal life insurance

1. What is universal life insurance?

Universal life insurance is a combination of two types of life insurance:¹

• Adjustable life insurance and permanent life insurance
• This combination combines term insurance which accrues cash value that earns tax-deferred interest.
• Interest rates depend on what type of universal life insurance policy you have and how your premium payments are invested.
• Universal life insurance offers more flexibility in premiums, death benefits, and savings, compared to whole life insurance premiums, cash value and death benefits.

The purpose of universal life insurance: flexibility

Universal life insurance was created to provide policy holders with more flexibility.²

Think of it as a hybrid life insurance policy that combines:

• Income protection
• Long-term investment features

The plans are flexible because you can increase or decrease the death benefit amount and make changes to how you pay premiums.

2. How universal life insurance premiums work

One of the big differences between universal life insurance and other types of life insurance products is how the premiums work.

So what makes universal life insurance premiums different and how does it work?

Here’s what you need to know…³

• Coverage + investing. When you pay premiums, a part is used to pay the costs of providing you with coverage, and the rest is invested by the insurance company to build cash value.
• Variable premiums. The flexibility of universal life means you don’t have to make fixed payments on a regular basis.
• You can decide how much and when you want to pay (subject to some limitations), which makes the premium variable.
• Cash-value requirements. The ability to change your premium payment is only available once your policy has built up enough cash value and after you have made your first regular premium payment.
• Premium payment options. You can pay premiums out-of-pocket or use your cash value to pay premiums.

3. Understanding the cash value of universal life insurance

One of the big differences between universal life insurance and term life insurance is cash value.⁴

• Term life insurance only pays out when you die.
• A universal life insurance policy can have a cash value you can access

However, there are a few things to keep in mind about accessing the cash value of a universal life insurance policy, including:

• Positive cash value. Maintaining a positive amount of cash value is very important with a universal life insurance policy.
• The premium impact. If you pay smaller regular premiums, or decide to use the policy’s cash value to pay premiums, the policy may run out of cash value.
• If there is no cash value left to cover the cost of the life insurance policy, and you don’t start paying premiums again, your coverage will end.
• But depending on the insurance company, there may be a guarantee that your coverage will remain in force even if the cash value isn’t enough to pay for the policy.

Universal life insurance: How to build cash value

Wondering how to increase the cash value of a universal life insurance policy?

• The cash value in this type of policy grows at a variable interest rate.
• It’s based on the performance of the insurance company’s investment accounts your cash value is kept in.
• The interest rate changes monthly, but it is guaranteed not to fall below the minimum rate the insurance company sets.
• Variable rates can mean you will earn higher interest, which will make your cash value grow faster. If the interest in the company’s investment accounts doesn’t grow as fast, then you will get the minimum rate of return.

Taking out a loan on the cash value of a universal life insurance policy

You can borrow against the cash value in your policy just as you would with other types of permanent life products.

• Borrowing. When you borrow against your policy, the loan you get is from the insurance company, and your cash value is only used as collateral.
• No qualification requirements. You don’t have to qualify to take out a loan, and it doesn’t have to be repaid.
• Repayment. If you decide not to repay, the interest on the loan will get larger and reduce your cash value, which may cause the policy to lapse.
• Death benefit deduction. If the loan is left unpaid when you die, the amount plus interest will be deducted from the death benefit, and your beneficiaries will receive less money.

Withdrawing money from the cash value

Universal life insurance lets you make a partial withdrawal of the cash value, which is usually tax free. Here’s a few things to consider:

• Withdrawal limits. Some policies allow you to withdraw up to 90 percent of the cash value, which is considered a permanent withdrawal.
• Taxes. Permanent withdrawals are subject to taxes and will also decrease the policy’s death benefit.
• Vesting period. In most cases, you are not allowed to withdraw money from the cash value in the first few years of the policy’s life.

4. Universal life insurance death benefit: How it works

With a universal life insurance policy, you can change your death benefit to fit your needs.5

Here’s an example: 

• If you need to cut back on household spending, you can reduce your death benefit so that you will pay less in premiums. 

Minimum premium⁶

The insurance company sets the minimum amount of death benefit you have to maintain to keep the policy active.

Increasing the death benefit

You can also increase the death benefit of a universal life insurance policy, but this usually requires passing a medical exam. 

• Increasing the death benefit will result in an increase in premiums.
• Before you make changes to your policy benefits or enroll in a plan, it’s a good idea to evaluate your life insurance policy and coverage needs.

A universal life policy offers two death benefit options:

• Level
• Enhanced

Level death benefit

This option guarantees that your beneficiary will receive the minimum amount of death benefit that the insurance company sets. 

• The amount you pay in premiums with a level death benefit depends on how much cash value you have in the policy.
• Remember, a universal life insurance policy’s cash value can be used to pay premiums. 

Enhanced death benefit 

Under this option, your beneficiary receives both the death benefit and the cash value. 

Here’s an example: 

• If the death benefit is $500,000, and the cash value is $100,000, a total of $600,000 would be paid out to your beneficiary upon your death (granted there are no outstanding loans).
• Note: This enhanced feature will usually cost more. 

The pros & cons of universal life insurance 

As with all types of life insurance, you have to decide if the advantages make up for the disadvantages of the plan you choose. 

Although there are some cons with universal life, one of pros is that insurance companies provide policy holders with an annual statement that breaks down all the expenses your premium payments cover and the amount of interest that goes into your cash value. 

Looking at more of these pros and cons side-by-side may help you better understand how universal life insurance policies work. 

Pros	Cons
●  Can pay less or more than the premium once your policy has cash value	●  Paying less in premiums can make your policy lose cash value
●  Can use cash value to pay premiums	●  If cash value isn’t enough to cover premiums, and you don’t pay premiums again, the policy will lapse
●  Some policies may continue even when the cash value ends	●  Not every policy may have this guarantee – policy usually ends once cash value is used up without further premium payments
●  Variable interest means you can earn more cash value if the interest stays at a higher rate	●  Interest rate changes month-to-month, so a higher rate of return is not guaranteed
●  Can change death benefit amount to be less or more to fit your financial needs	●  Increasing the death benefit often means taking a medical exam

3 types of universal life insurance policies

Did you know there are three main types of universal life insurance policies? 

• Fixed universal life
• Fixed-index universal life
• Variable universal life 

All three involve some risk. Why? The interest the cash value earns depends on either: 

•     The performance of the insurance company’s investment portfolio, an index account, or…
•     The stock market 

Let’s take a closer look at each type of universal life insurance:7

Guaranteed universal life

This type of universal life insurance policy is typically the lowest risk.

Why? The growth of the interest is based on the insurance company’s overall investment portfolio. 

• Many insurance companies invest most of their portfolio in fairly safe bonds.
• But the downside of safer bonds is that you usually get a lower rate of return, which can mean your cash value won’t grow as fast.

Indexed universal life

This is usually the middle ground between the least risky and the most risky type of universal life insurance.

• An indexed policy lets you decide the percentage of cash value you want to invest.
• While the cash value isn’t directly invested in the stock market, the growth of the interest is based on the financial value of one or more indexes, such as the Nasdaq-100 and Standard & Poor’s (S&P) 500.
• One of the pros with this type of policy is that if you make a high return, that return is locked in. So, if the market goes down at a later time, you won’t lose the interest you’ve already earned. Because these policies aren’t managed, the cost is usually less expensive.

Variable universal life

This is typically the most risky type of universal life insurance.

Why? The rate of return is tied to the performance of managed funds. This is both an advantage and disadvantage. 

• The big payoff is that if investment funds (money market mutual funds, stocks, or bonds) perform well, the interest gained can be more than what you would get in the other two types.
• This means you have the potential to build a large amount of cash value quickly.
• But if funds don’t perform well, you may end up paying higher premiums (because the investment part of the policy is managed) only to not get the high return you were expecting. 

7. Who should get universal life insurance

Are you a good fit for universal life insurance?

Here’s a good place to start…⁸ 

• The cash-value feature of universal life insurance typically makes it more expensive than temporary or term life insurance.
• People who get a universal life insurance policy generally have the income to afford a policy with higher premiums in exchange for the potential to build a lot of cash value.

Universal life insurance is typically recommended for the following two groups:8 

1. High-income earners and those looking for more flexibility:

• An indexed universal life (IUL) policy may work best for people whose incomes are too high to qualify for a Roth IRA and who find their other tax-deferred accounts to be inflexible.
• An IUL policy may be a good fit for these types of people because they can put as much money as they want into the policy (federal limits apply) to build a large cash value, and they can withdraw money from the policy at any age without a penalty.

2. Retirees 

For those who have maxed out the money in their retirement accounts, an IUL policy may be a suitable option. 

• Overall, it is suggested that universal life can be a good fit for the wealthy baby boomer market or those nearing or already in retirement.
• This is because the policy may provide for a long-term, tax-free stream of retirement income when premiums are paid and when certain insurance riders are added to the policy, such as a longevity rider. 

Additional features: 

Several additional features of universal life insurance to ask your agent about include: 

• Terminal illness provision that allows you to take money out of the policy without penalties if you’re diagnosed with a terminal illness with less than 12 months to live.
• Critical illness provision that allows you to access policy funds without penalty to pay for things like home healthcare, assisted living, and long-term care needs.

Is a universal life insurance policy right for you?

If you’re looking for universal life insurance to help protect your family and leave a legacy, there are lots of options to consider. 

A licensed life insurance agents can help answer your questions, review plans and enroll when you’re ready. 

Just give us a call at (800) 827-9990 or find a licensed insurance agent in your area.