Whole life insurance can be pricey. Term life insurance, while more affordable, only offers limited-time coverage. Universal life insurance, on the other hand, can provide full-life coverage, like whole life does.
But overall costs are often lower than whole life. Here’s what you’ll need to know before choosing the right policy to protect your family.
What is universal life insurance?
Universal life insurance is a type of policy that combines life insurance with a cash account that can grow over time.
How does universal life insurance work?
Universal life uses a renewable term life policy to provide a death benefit. Because the term policy renews each year, your coverage is permanent. By contrast, a standard term policy can expire, leaving you without protection.
A universal policy also uses a cash value account. This cash account can help pay the premiums later in life. Without this cash account, the term premiums can become expensive as you get older.
In effect, you’re saving money within your policy that can pay part or all of your premiums later. This structure makes a universal life policy flexible.
There may come a time when you can’t pay the premium for a month or two. If you have enough saved in your policy, your policy may be able to pay the premium for you.
But you also have to be careful with a universal life policy. The cost of insuring your life rises each year. With age, comes more risk. Some other types of policies average this risk to give you a flat premium each year.
Your costs don’t change. However, a universal policy uses a renewable term policy to provide life insurance. This structure can become pricey as you get older and the risk of death increases. Thus, it’s important to fund the policy well in the early years.
Types of universal life insurance policies
Not all universal life policies work in the same way. Let’s examine some popular types.
Indexed universal life (IUL)
As its name suggests, a indexed universal life tracks an index. Remember, the premium you pay gets split 2 ways. One part goes toward your cost of insurance. The other part goes to the cash account.
For example, the cash account might track the S&P 500 index. Historically, the S&P index has performed well for investors. However, in an indexed life policy, you won’t earn dividends like you would with an S&P 500 ETF or mutual fund.
Instead, returns are based on the price growth of the stocks within the index. The S&P is only one example. Indexed policies can also track other indexes. By now, you’re probably wondering why the cash account doesn’t earn dividends from the index as well.
After all, the historical S&P dividend return is nearly 2%. That’s a lot of money. Indexed life policies don’t pay dividends. Instead, they create a floor under your cash account value.
Markets go up and markets go down. An indexed life policy sets your downside at 0% gain. However, there may also be a cap on gains. The real draw is that indexed life helps protect your downside.
When you buy an indexed life policy, you’re betting on an average rate of growth in the cash account. Your cash account can help pay premiums later as the cost of insurance rises.
Guaranteed universal life (GUL)
Most universal life policies build cash value. However, guaranteed universal life is an exception by design. With other types of universal policies, there’s an investment element, which can bring risk.
If the cash account doesn’t perform well, you may have to make extra payments to cover the cost of insurance. Those extra payments may come due when you need your money elsewhere, possibly causing the policy to lapse.
Guaranteed universal life answers these concerns by offering fixed premiums. It also eliminates the cash account that’s common to other types of policies.
In many ways, a guaranteed policy acts much like a term policy. Premiums are fixed and the insurer bases rates on risk. However, with a term policy, your rates can explode after the term has expired.
A guaranteed life policy provides level rates up to an age you choose, which can be as high as age 121. The guarantee is that your policy won’t lapse, as can happen with an under-funded universal policy.
However, you still have to pay premiums. Because the policy doesn’t build cash value, it can’t cover your premiums when money gets tight.
Variable universal life (VUL)
Like an indexed policy, a variable universal life policy allows flexible premiums. The cash account can help pay your premium. However, a few key differences set the 2 policy types apart.
A variable policy introduces more risk — but it may also bring greater rewards. An indexed policy sets a floor at 0% gains and caps performance. However, the cash account in a variable policy can go up — or down.
If the cash account’s investments go down in value, your cash account goes down as well. In some cases, the cash account value can be wiped out altogether.
On the other hand, if the investments perform well, there’s no cap on performance in your cash account. This can help a variable life cash account to grow its cash value faster than other types of life policies.
Later in life, the cash account can pay some or all of your premiums. Variable life removes the safety rails, making your policy act like a true investment. These policies are treated as securities and are only sold through FINRA licensed agents.
Universal life insurance pros and cons
Universal life isn’t a fit for everyone. Here are some pros and cons to look at before choosing.
Pros of a universal life policy
- Premiums are flexible. Your cash value can cover the cost of premiums if needed.
- Costs can be lower. Premiums are often lower than whole life.
- Cash value can grow faster. In many cases, account performance can grow cash value faster than with whole life’s fixed returns.
Cons of a universal life policy
- Premiums increase. The cost of insurance increases with a universal policy, so premiums are higher later in life.
- Some policy types put your cash value at risk. If the investments have negative returns, your cash value can go down.
- Your policy can lapse. Any type of life policy can lapse if you don’t pay premiums. However, universal life can have more risk because the cost of insurance is high later in life.
Universal life insurance vs. term insurance
Term insurance can be great if you need to insure for a fixed amount of time. Buying a home or starting a family are common reasons for buying term life.
However, if you need coverage after the term expires, keeping the policy alive can be pricey. Term policies don’t build cash value, so you you have to pay the premiums out of pocket.
Expect to pay more for a universal life policy. However, the cash account can cover part or all of your premiums later in life. A well-funded universal policy can provide lifelong coverage.
Universal life insurance vs. whole life insurance
Both whole life and universal life build cash value. They both also provide coverage that won’t expire. However, there are some key differences.
A whole life policy guarantees cash value growth based on dividends. However, you usually can’t use cash value to pay premiums unless you convert your policy to a paid-up policy.
Whole life also features fixed premiums, which allows you to budget for a fixed expense. Universal life removes some constraints and lets you use your cash value to pay premiums.
In fact, without that structure, a universal life policy may become too expensive as premiums rise later in life. Universal life also allows you to grow the cash value faster when compared to a whole life policy.
Q&A about universal life insurance
Can you cash out a universal life insurance policy?
There are 2 ways you can get cash out of a universal life policy. Often, the easiest way is to surrender the policy to the insurer. In this case, the insurer pays you a fixed amount based on the cash value the policy has accumulated.
However, the amount you get can vary based on fees, which can be high. Alternatively, you can sell the policy to a life settlement company.
Does universal life insurance expire?
Insurers design a universal life policy to be a permanent policy. It doesn’t expire after a set amount of time like some term policies. However, like all insurance policies, the premiums must be paid for the policy to remain in force.
What happens when a universal life policy matures?
In most cases, the insurer pays you the policy’s cash value when the policy matures. However, coverage also ends, so the policy won’t pay a death benefit. Rules vary by insurer or by policy, but most policies mature between age 85 and 121.
What happens to cash value in a universal life policy at death?
With universal life, the insurer absorbs the cash value when the policy pays a death benefit. If your policy’s death benefit is $150,000 and you have a cash value of $50,000, the insurer pays $150,000.
The $50,000 in cash value is absorbed. However, you can use cash value to pay premiums or use your cash value in other ways.
Does universal life insurance have a cash surrender value?
Like whole life policies, a universal life policy also has a cash surrender value. However, the cash value and the surrender value may not be the same. Insurers use fees to deter cash surrenders, especially during the early years of the policy.
Cash values are usually low during the early years of the policy. Your policy statement provides details on the cash value and surrender value.
Is cash surrender value of universal life insurance taxable?
Part of the money you receive from a cash surrender may be taxable. The difference between the premiums you’ve paid on the policy and the cash surrender payout is subject to tax.
For example, if you’ve paid $20,000 in premiums and surrender the policy for $30,000, you pay taxes on $10,000.
What is the average premium for universal life insurance?
Life insurance rates can vary widely based on individual factors, including age, health, and insured amount. For example, a 40-year-old male non-smoker in good health might pay about $125 per month for a $250,000 UL policy.
That same person might pay $70 per month at age 25. They might pay nearly $300 per month if buying coverage at age 55.
Why is universal life cheaper than whole life?
Universal life often provides a higher return than you’ll find with whole life policies. When you pay the premium for a universal policy, part of the premium pays for the cost of insurance.
The balance goes to your cash account which may be invested in stock funds or other assets. Higher returns allow for a lower overall premium.
Can a universal life policy be paid up?
Products such as single premium variable life (SPVL) allow you make a single premium payment and purchase coverage for life. Additional premium payments can increase your coverage amount.
Is universal life a participating policy?
Universal life policies can invest in several ways, but policyholders aren’t owners of the insurance company. They don’t earn dividends from the insurer. Universal life and variable policies are nonparticipating.
Can you sell a universal life insurance policy?
In many cases, you can sell a universal life policy to a life settlement company. Typically, selling your policy gives you more money than surrendering your policy. The buyer assumes the premium payments and collects the death benefit when you pass away.
Choose a universal life policy for lifetime coverage
Term life insurance is an easy-to-understand product. Whole life adds a bit of complexity but is still fairly clear to most buyers. Universal life steps up earning potential but also steps up the learning curve.
For most buyers, the biggest risk is that the life policy becomes under-funded, which can lead to big premium payments. Universal policies use a renewable term policy to provide a death benefit.
As you get older, risk increases and the cost of term insurance goes up as well. If the cash value hasn’t increased as hoped, you may have to put more money in to keep your coverage.
Universal life may be best for people who can afford to top off the cash account if performance isn’t as strong as hoped in a given year. Guaranteed universal life is worth a closer look if you want lifetime coverage and fixed premiums.