A Guide to Universal Life Insurance

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Universal life insurance pays variable interest, so it could earn more than whole life policies.

Universal life is a good choice for buyers who want life insurance that will last until their death, build cash value, and offer flexibility in terms of payments and benefits. Universal life insurance is a policy that covers your whole life. This is unlike term life. You’ll earn market-based interest on the account balance, unlike whole life.

The increased control over whole life insurance is accompanied by greater responsibility and more variability. Universal life is a good option if you don’t find that too burdensome.

What is life insurance?

Universal life insurance is a type of permanent insurance, covering you until death just like a whole life policy. Variable interest is a component of universal life policies that allows you to change the premium payments depending on market rates, such as Treasury bills. You can also change the amount of your death benefits by purchasing universal policies.

Universal life is referred to as “universal” because it can be used by anyone who has any needs. Universal policies can be used to cover any need, whether it’s a large payment or a small one.

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These are the main characteristics of life insurance:

  • You can borrow against your policy’s cash-value component if it has enough value.
  • Cash-value accounts earn interest at the market rate.
  • If you are eligible, you have the right to increase or decrease your death benefit. You may need to adjust your premiums or have a change of coverage.
  • To increase your cash account’s value, you can pay more than the recommended Premium.
  • To make up the difference, you can pay less than the recommended premium. You can also draw from your account to make up the difference. You may be able stop payments in certain cases.
  • Your money is subject to fluctuations in benchmark interest rates, most notably those set by Federal Reserve.

Since 2008’s financial crisis, universal life policies have been increasing in popularity. In particular, sales of an index universal life subset of universal insurance started to rise. The non-variable universal policy is now the most widely used type of life insurance.

How universal life insurance works

Two main components make up permanent — also known as “cash value”, life policies. The insurance is the first. This is the insurance that pays you when you die. Insurers will charge you the “cost of insurance” (COI). This portion gets more expensive as you age.

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The cash-value account is the second. The insurance company will charge you a premium and then take out administrative fees and deposit the remainder into your cash-value bank account.

This cash value, which is part of a universal life policy pays interest based upon the performance of the general account.

What is in this account? There is nothing very exciting — mostly bonds with some stocks and mortgages mixed in. The minimum guaranteed rates for universal life insurance are often lower than the market rate. This is dependent on the insurer as well as the current interest rates.

Life insurance has many benefits

The major benefits of universal life are market rates and control.

Flexible premiums and coverage offer control:

  • You can change the amount and frequency of your payments with universal policies. If you have more money, you can either overpay or underpay. You may have to pay less if you are unable to pay. Before making any changes, consult a financial advisor.
  • A universal life policy can be used to modify your death benefit. You can easily increase your death benefit if you have more coverage or can pass a medical exam. You can fill out a form to reduce your benefit.
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Your cash-value account will earn interest at the market rate based on the insurer’s general account investments. It’s possible to make more with your cash-value account than you would with a whole-life policy that has a fixed, guaranteed rate.

Universal life has its disadvantages

Universal life has its advantages and disadvantages.

  • Increased responsibility comes with greater control. It is possible to miss payments, overpay or underfund your account. You could end up having to make large payments to keep the coverage you have signed up for.
  • Market rates bring volatility. Universal life insurance is a great product when interest rates rise. Over a decade, interest rates have been below 3.3%. The more rates change since the time you purchase a policy the less accurate your original payment projections and account value projections.

Universal life insurance vs. Whole life

Whole life policies provide permanent coverage for a fixed premium with a fixed death benefit. Your COI is overpaid at the beginning of your policy’s existence. You’re now underpaying for your COI at the end of the policy. The whole-life policy spreads the cost of that policy in a similar way to a mortgage.

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Universal life does not have the same feature. While you need to be able to afford the COI coverage, you don’t necessarily have to overpay.

A universal life cash value account is typically funded in greater amounts during the first few years. This builds account value, begins the interest-earning process, and provides a buffer for later years. You should then be able decrease your payments over time.

Optional death benefits from universal life insurance

The payment of your death benefit will be one of the most important decisions you make when purchasing universal life insurance. Two options are available:

  • The policy’s death benefit should not change over the course of the policy’s life. If you sign up for $100,000 and accumulate $60,000 cash value to pay premiums, then your beneficiaries will get $100,000.
  • To calculate the death benefit, add the cash value to your cash-value account. In the above example, the death benefit and cash value would be added to $160,000.

The second option is more costly because it means that the cash account your insurer would normally keep after your death is over to beneficiaries.

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Riders on universal life insurance

Your insurance company might offer a variety of riders to your universal life policy. Your life insurance policy riders can be added to your contract to make the policy more efficient. These riders can be added to your policy with additional features or guarantees. However, they are all optional and may come with a charge.

  • No lapse guarantee. Life insurance policies that are exposed to the marketplace may not perform as expected. Your policy could end up costing you more than you thought. There are no lapse guarantees. Your death benefit will continue to be in effect as long as you pay the minimum premium.
  • Waiver of premium. This allows you to cancel your payments if necessary. This is basically insurance for your insurance.
  • If you have suffered a major medical setback such as a stroke or heart attack, you can access your death benefit sooner. — or if your terminal illness is diagnosed. Each condition is treated differently by different insurance companies. Make sure you check your benefits and which illnesses are covered.
  • Family riders. You can add child and spouse riders to your universal life insurance policy.
  • Accidental death. If you are killed in an accident or suffer from injuries, these riders will increase your payout.
  • Guaranteed insurability allows you to increase your death benefit at certain life stages or policy anniversary without undergoing a medical exam. You could, for example, increase your death benefit if your child was born even if your medical condition has changed.
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How to choose the best universal life insurance company

Universal life policies can be complex. To find the right company you will need to consider a few factors.

First, you want to choose a life insurance company that is financially sound. This will ensure your cash-value account and beneficiaries receive a payout if you pass away. A.M. Best and Standard and Poor’s can provide financial strength ratings for most businesses, although you might need to log in to verify. A letter grade of A or higher from A.M. will indicate a solid life insurance company. Best.

You should also ensure that you find a company offering the policy options you are looking for. Some riders may not be offered by every company. You can purchase universal life insurance with different guaranteed minimum interest rates, and different fee structures.

Finally, you should consult with a financial advisor — fee-only financial planners can help you here — to better understand how the company’s products differ and which one is right for your long-term goals.