What Is Universal Life Insurance (UL)? Benefits and Disadvantages

What Is Universal Life (UL) Insurance?

Universal life (UL) insurance is permanent life insurance (lasting the lifetime of the insured) that has an investment savings element and low premiums similar to those of term life insurance. Most universal life insurance policies contain a flexible-premium option. but some require a single premium (single lump-sum premium) or fixed premiums (scheduled fixed premiums).

Key Takeaways

  • Universal life (UL) insurance is a form of permanent life insurance with an investment savings element plus low premiums.
  • The price tag on universal life (UL) insurance is the minimum amount of a premium payment required to keep the policy.
  • There are no tax implications for policyholders who borrow against the accumulated cash value of their UL insurance policy.
  • Unlike term life insurance, a UL insurance policy can accumulate cash value.
  • You can borrow from any accumulated cash value in your policy.
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What's Universal Life Insurance?

How Universal Life (UL) Insurance Works

A UL insurance option provides more flexibility than whole life insurance. Policyholders can adjust their premiums and death benefits. UL insurance premiums consist of two components: a cost of insurance (COI) amount and a saving component, known as the cash value.

As the name implies, the COI is the minimum amount of a premium payment required to keep the policy active. It consists of several items rolled together into one payment. COI includes the charges for mortality, policy administration, and other directly associated expenses to keeping the policy in force. COI will vary by policy based on the policyholder’s age, insurability, and the insured risk amount.

Collected premiums in excess of the cost of UL insurance accumulate within the cash value portion of the policy. Over time the cost of insurance will increase as the insured ages. However, if sufficient, the accumulated cash value will cover the increases in the COI.

Universal Life Insurance
Investopedia / Ellen Lindner.

Advantages and Disadvantages of Universal Life Insurance

Much like a savings account, a UL insurance policy can accumulate cash value. In a UL insurance policy, the cash value earns interest based on the current market or minimum interest rate, whichever is greater. As cash value accumulates, policyholders may access a portion of the cash value without affecting the guaranteed death benefit. However, the withdrawals will be taxed.

Also, depending on when the policy and premium payments are made, earnings will be available as either last in, first out (LIFO) or first in, first out (FIFO) funds. Upon the death of the insured, the insurance company will retain any remaining cash value, with beneficiaries only receiving the policy’s death benefit.

Universal life policyholders may borrow against the accumulated cash value without tax implications. However, if they do, interest will be calculated on the loan amount, and there will be a cash surrender fee. Unpaid loans will reduce the death benefit by the outstanding amount, with unpaid interest on the loan deducted from the remaining cash value.

Unlike whole life insurance policies, which have fixed premiums over the life of the policy, a UL insurance policy can have flexible premiums. Policyholders can make payments that are more than the COI. The excess premium is added to the cash value and accumulates interest. If there is enough cash value, policyholders may skip payments without the threat of a policy lapse.

That said, policyholders must be attentive to the rising cost of insurance as they age. Depending on the credited interest, there may not be enough cash value to keep the policy in force, thus requiring them to pay higher premiums. Missed payments must be paid within a specific time frame for the policy to remain in force.

Pros
  • You may borrow from your cash value.

  • Lasts your lifetime

  • Provides both a death benefit and a cash value account

Cons
  • Withdrawals of cash value component are taxed.

  • When a policy holder dies, the company keeps the account's cash value.

  • You must pay back a policy loan with interest.

Universal Life Insurance vs. Term Life Insurance vs. Whole Life insurance

Universal life, a form of permanent life insurance provides policyholders with flexibility on paying premiums, a cash savings component, and a death benefit. Premium costs may change with interest rates and as the policyholder grows older.

Universal life insurance allows you to borrow against or cash in their savings portion, which grows, tax-deferred over your lifetime. Term life provides coverage, often through an employer, for a set number of years, generally, 20 or 30, and expires once the term is up. Term life is usually affordable, with low premiums, but there is not a cash component to borrow from or cash in, and the death benefit is null and void if you die after the term is up.

Whole life insurance is also a form of permanent life insurance, with a cash value savings component. Another important difference between universal and whole life insurance is that universal life insurance has more flexibility in where you can invest your policy's cash value account. Whole life insurance premiums are locked in for the life of the policy, whereas universal premiums are flexible.

What Is Universal Life Insurance and How Does It Work?

UL insurance policies are a form of permanent life insurance with flexible premiums. Unlike term life, can accumulate interest-bearing funds like a savings account. Also, policyholders can adjust their premiums and death benefits, and holders paying extra toward their premium receive interest on that excess.

What Is the Disadvantage of Universal Life Insurance?

A big disadvantage is that holders must keep their eyes on fees. They will be taxed on cash withdrawals, and interest is charged on loans. Holders should also pay attention to rising premiums as they age because there's a chance enough cash may not be available to keep the policy active, and the holder will be forced to pay higher premiums.

Which Is Better Whole Life or Universal?

Both whole life and universal life are forms of permanent life insurance and provide a cash value savings component that policyholders may borrow from or cash out. Whole life offers fixed premiums, universal premiums, may start out lower, but they are flexible and may increase as you age. Depending on the amount of coverage and flexibility you want in a permanent policy, either form may be a good choice, depending on your situation.

What Is the Difference Between Universal Life Insurance and Whole Life Insurance?

Whole life insurance is more stable because the death benefit will never go down if you pay our premiums, which are fixed monthly amounts. Universal life insurance offers more flexibility, but your death benefit is not guaranteed. If you borrow too much against the policy, the benefit will decrease, but you can design your coverage for many years or your lifetime. You can increase or decrease your death benefit and the amount you spend on premiums.

Can I Cash Out My Universal Life Insurance Policy?

You can sell your universal life insurance policy, or you can liquidate the cash value component and cancel the policy, but you will have to pay a surrender fee.

Article Sources
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