Universal Life Insurance

What is 'Universal Life Insurance'

Universal life insurance is permanent life insurance with an investment savings element and low premiums like term life insurance. Most universal life insurance policies contain a flexible premium option. However, some require a single premium (single lump-sum premium) or fixed premiums (scheduled fixed premiums).

BREAKING DOWN 'Universal Life Insurance'

A universal life insurance option provides more flexibility than whole life insurance. Policyholders have the flexibility to adjust their premiums and death benefits. Universal life 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 cost of insurance 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 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 Cash Value

Much like a savings account, a universal life insurance policy can accumulate cash value. In a universal life 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. A policyholder will pay taxes on any withdrawals they make from the excess cash value of the universal life insurance plan. 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. Beneficiaries will receive only the policy's death benefit.

Universal life policyholders may also borrow against the accumulated cash value without tax implications. However, interest will be calculated on the loan amount, as well as 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.

Universal Life Flexible Premiums

Unlike whole life insurance policies, a universal life insurance policy has flexible premiums. The whole life insurance policy has fixed premiums over the life of the policy. Missed payments must be paid within a specific time frame for the policy to remain in force.

The universal life policyholder has the flexibility of remitting premiums over the cost of insurance (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. Although there is flexibility with premium remittance, policyholders must be attentive to the rising cost of insurance and plan accordingly. Depending on the credited interest, there may not be enough cash value to keep the policy in force, thus requiring higher premium payments from the policyholder.