Universal life insurance

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Choosing life insurance is a big decision, especially when there are so many options to consider. You want to make sure you’re leaving behind more than just memories — you want to provide financial support for those who matter most to you. While term life insurance offers affordable coverage for a set number of years, what if you’re looking for something permanent with added flexibility? Universal life (UL) insurance could be the solution. It’s designed to provide lifelong coverage while giving you the freedom to adjust your premiums and coverage amount as your needs change. In this guide, Bankrate’s insurance editorial team will walk you through how universal life insurance works, helping you determine whether it might be the right fit for your long-term financial goals.

What is universal life insurance?

Universal life insurance is a type of permanent life insurance designed to provide lifelong coverage, typically lasting until ages 95 to 121. When you pay your premiums, a portion goes toward covering the cost of insurance, which funds the death benefit. The remaining portion is allocated to a cash value component. This cash value accumulates interest over time, creating a flexible financial resource you can access during your lifetime.

The cash value in a universal life policy can be accessed through policy loans or direct withdrawals.

• Policy loans: Allows you to borrow against your policy’s cash value. The loan accrues interest but doesn’t require repayment. However, if not repaid, the outstanding balance (including interest) reduces your death benefit.
• Withdrawals: Enables you to directly withdraw cash from your policy. Withdrawals permanently reduce both the cash value and death benefit. They do not accrue interest or require repayment.

While tapping into your policy’s cash value can be beneficial for immediate financial needs, it’s important to understand that doing so may have long-term consequences. If the cash value falls too low, it could lead to higher premiums or even cause your policy to lapse.

Universal life insurance strikes a balance between permanent coverage and financial flexibility, making it an appealing choice for those who want both lifelong protection and access to funds when needed.

Flexibility: the key advantage of universal life insurance

One of the primary reasons people choose universal life insurance is the flexibility it offers. Unlike whole life insurance, which locks you into fixed premium payments, UL allows you to adjust how much you pay as your financial situation changes. This adaptability is designed to help you navigate the ebbs and flows of life — pay more when you can and pay less when money is tight. Some other key aspects of the flexibility a universal life policy offers are:

• Customizable premium payments: Universal life insurance policies require a minimum level of premium payments during the first year. After that first year, policyholders can decide how much to pay or even skip payments altogether as long as the policy’s cash value can cover the insurance costs and administrative charges. However, if the cash value drops too low, the policy may lapse.
• Targeted premium strategy: For those seeking consistency, UL offers a targeted premium option. You can aim to pay a set amount over time, similar to whole life insurance, with the goal of keeping the policy active until age 95 or 121. However, if the cash value underperforms, you may need to either increase your premiums or reduce the death benefit to maintain coverage.
• Prefunding for long-term benefits: Some policyholders choose to prefund their UL policy, making higher payments in the early years. This strategy helps build cash value more quickly, which could reduce premiums later on or even allow the policy to sustain itself.
• Flexible death benefit options: With universal life insurance, you can choose between:
  • Level death benefit: The death benefit remains consistent, similar to whole life insurance.
  • Increasing death benefit: The benefit grows along with the cash value, although premiums are typically higher.

The flexibility of universal life insurance is designed to align with your financial goals and evolving needs, whether you prioritize adjustable payments, building cash value or customizing your death benefit options.

What are the different types of universal life insurance?

While the overall concept of universal life insurance is much more flexible compared to a term life policy and even other permanent policies, there are a few different types of universal life insurance you can choose from depending on your goals and financial situation.

Indexed universal life policies

Indexed universal life (IUL), also known as equity-indexed universal life insurance, links your policy’s cash value growth to a stock market index, such as the S&P 500. While this offers the potential for higher returns than traditional policies, gains are usually capped, and administrative fees are deducted. IUL policies also provide downside protection, ensuring that even if the market performs poorly, your cash value won’t drop below a specified minimum. However, due to these variable factors, IUL policies carry more complexity and potential risk than other universal life insurance options.

Variable universal life policies

Variable universal life (VUL) policies combine the flexibility of universal life insurance with the investment options of mutual funds. Unlike indexed universal life, VUL allows policyholders to diversify their cash value into multiple sub-accounts, including money market funds, bonds and stock portfolios. While this offers potentially higher returns, it also comes with increased risk as the cash value fluctuates directly with market performance. Additionally, administrative and management fees can impact returns, making it important for policyholders to monitor their accounts regularly to avoid lapses if the cash value falls too low.

Guaranteed universal life policies

This is a low-risk option designed to have a fixed premium for your entire life if you pay the target premiums in full, on time. It’s not a growth-oriented type of universal life insurance policy, but it also doesn’t have the volatility of other universal life policies.

What are the pros and cons of universal life insurance?

Universal life insurance can be a versatile financial tool, but it’s important to understand both the advantages and disadvantages, especially if you’re considering this policy type for its long-term flexibility.

Pros:

• Flexible premium payments: Universal life insurance allows you to adjust your premium payments. As long as there’s enough cash value to cover costs, you can pay more during good financial periods or reduce payments when finances are tight. For example, if you experience a financial setback, you might opt to lower your premium payments temporarily as long as the policy’s cash value can cover the necessary charges.
• Adjustable death benefit: You have the flexibility to increase or decrease the death benefit. Increasing it may require a medical exam, which could increase premiums, but this flexibility allows the policy to adapt to changing needs. For instance, if you originally purchased the policy to cover your mortgage and later pay it off, you could reduce the death benefit and lower your premiums.
• Cash value with a guaranteed floor: Some universal life policies, such as IUL and VUL, have a guaranteed minimum interest rate (floor) that prevents your cash value from declining too much, even if the market underperforms. For example, if the floor is set at two percent, your cash value will still earn at least that rate, regardless of market performance, offering peace of mind in volatile times.

Cons:

• Growth cap on earnings: While the floor protects your downside, IUL policies also include a cap that limits how much interest your cash value can earn, even if the market performs exceptionally well. For example, if the cap is set at eight percent, any returns above that won’t be credited to your policy, potentially limiting growth when the market is strong.
• Active management required: Regular monitoring is necessary to ensure your cash value remains sufficient to cover costs. If the cash value runs low due to lower crediting rates or extended low premium payments, you might have to pay more to keep the policy in force. For example, if your cash value drops unexpectedly, you may need to either inject more money into the policy or risk it lapsing.
• Slower cash value accumulation: Cash value in universal life policies typically grows slowly compared to actual investments, such as investing directly into the stock market. For instance, it could take several years before your cash value reaches a level where it can be meaningfully accessed for loans or withdrawals, making it less suitable if you need quicker liquidity. Universal life policies also have surrender charges for the first ten to sixteen years which impact liquidity.
• Potential for rising premiums over time: If you only pay the minimum required premiums, these costs can increase as you age, especially as the cost of insurance rises due to higher mortality charges. For example, while the initial premium might be affordable in your 40s, it could become much more expensive in your 70s if the cash value depletes and additional premium payments are needed to keep the policy active.

Is universal life insurance worth it?

Universal life insurance can be appealing due to its flexibility and lifetime coverage, allowing policyholders to adjust premiums and death benefits as their financial needs change. The potential to build cash value that can be accessed later through loans or withdrawals adds another layer of versatility, especially for those looking for more control over their policy. However, the complexity and higher costs associated with managing a universal life policy mean it may require careful monitoring to ensure the cash value remains sufficient as insurance charges increase with age.

Whether universal life insurance is worth it depends largely on your long-term goals and ability to actively manage the policy. If you value customizable coverage and the option to accumulate cash value, it could be a beneficial choice. However, for those who prefer simpler, more straightforward coverage with lower costs, other options like term life or whole life insurance might be more suitable. Consulting with a financial advisor can help you weigh these factors against your overall financial plan and determine if universal life aligns with your needs.

Frequently asked questions

• What is the best life insurance company?

  There is no single “best” life insurance company for everyone, as the right fit depends on individual needs and circumstances. Different insurers have varying underwriting criteria, so the best choice can differ based on factors like your age, health and the specific type of coverage you’re looking for. For example, if you have a pre-existing medical condition, one company might offer more favorable rates than another. Shopping around is crucial. By comparing quotes from several providers, you can have better odds of finding a policy that meets your needs while fitting within your budget. Remember, the goal is to choose a provider that aligns with your long-term financial plans and offers the right balance of coverage and cost for your situation.

• What is the difference between whole and universal life insurance?

  While both whole and universal life insurance are permanent life insurance policies, there are some key differences. Whole life insurance offers a fixed premium and a fixed death benefit for the duration of the policy. These policies will build cash value over time, though slowly, while a universal policy’s cash value could grow faster, depending on its returns. A universal life insurance policy can also have a premium that fluctuates based on its cash value and your shifting death benefit needs. Universal plans are known as being generally higher risk and potentially higher reward than whole life insurance plans.

• Should you cash out your universal life insurance policy?

  Deciding whether to cash out your universal life insurance policy is a significant choice that depends on your financial goals and current needs. While some people choose to cash out during a major financial emergency, there are other reasons this could make sense. For example, if your life insurance needs have changed, such as your children being grown or no longer needing coverage, cashing out could be a consideration.

  However, there are a few things to keep in mind. If your policy isn’t that old, surrender fees may apply, especially within the first few years. These fees are usually highest in the first year and gradually decrease over 10 to 15 years. Additionally, if your surrender cash value (SCV) is greater than your cost basis, the difference may be subject to income taxes. Previous withdrawals or outstanding policy loans will also reduce the amount you receive. Before deciding, it may be beneficial to consult with a financial advisor to understand the full financial implications.