Universal life insurance provides lifetime coverage, as well as flexibility in premium payments and the investment of the policy’s cash value. The cash value of a traditional universal life insurance policy fluctuates depending on the performance of the index, and can then be used to pay policy premiums.
Life insurance variations – variable and indexed universal life insurance – afford you multiple options when investing the policy’s cash value. While both universal life and whole life insurance provide you with lifelong coverage, whole life offers more policy options and is typically less expensive.
How Does Universal Life Work?
A form of permanent insurance, universal life provides lifetime coverage as long as your premiums are paid. This differs from term life insurance, which expires after a specified time period, such as 10 or 20 years. Although universal life insurance can be purchased by individuals, it is often extended by employers as a group policy.
Premium Payments and Cash Value Component
The cash value component of a universal life insurance policy is separate from the death benefit. Each time a premium payment is made, a fraction goes towards the actual cost of insurance (including administrative fees and the death benefit) while the remaining amount is deposited into a cash value account. This cash value is then guaranteed to increase according to a minimum annual interest rate but has the potential to build faster as a result of the selected market’s performance.The cash value of a universal life insurance policy can be used as the following:
- Premium Payments
The cash value can be used to pay a portion or the entire amount of a premium payment. However, you will need to be sure that the cash value does not drop below a zero balance or the policy will lapse.
- Loan Collateral
You will have the ability to borrow from your insurer and use your cash value as collateral – with your cash value being the maximum amount that you can borrow. These types of policy loans are typically subject to interest rates set by your insurer.
- Surrender Value
In the event that you decide that you no longer wish to keep your policy, you can surrender it to your insurer and receive the cash value in return.
Since the premium of a universal life insurance policy is split between the cost of insurance and the cash value, you are able to select the amount you pay as long as it is between the minimum and maximum amounts due. Some individuals decide to pay the maximum premium possible during the first few months in order to grow their cash value, then they use the cash value to pay their premiums in the future.
While this is a smart strategy if your desiring to maintain your permanent coverage, the drawback is that the reduction in cash value may cause you to be responsible for paying the full cost of insurance with no surrender value available for your policy. Furthermore, as mentioned before, if your cash value reaches a zero balance, your policy may lapse.
If the cost of your insurance increases, depletion of your cash value would not be good. While the cost of insurance can remain fixed throughout the life of the policy, this isn’t necessarily typical. Generally speaking, there’s both a minimum and maximum cost of insurance. With your increasing age, the minimum premium that you would have to pay will increase substantially. Should this happen once your cash value is exhausted, your policy could lapse – which means there is no coverage. Therefore, it is crucial that you monitor your policy’s cash value, especially if you use it to pay your premium payments.
When Does Universal Life Insurance Mature?
The maturity date for universal life insurance policies is usually once you reach the age between 85 and 121, depending on your carrier. When your policy reaches its maturity date, you will receive a lump-sum payment and your coverage will cease. The payment you will receive will either be the death benefit or an amount based on or equal to the policy’s cash value.
Unfortunately, this can be an issue should you live past your policy’s maturity date and you have borrowed from the cash value in order to pay your premiums. You could wind up with zero coverage and little if any money disbursed to you. Accordingly, choose a policy with a reasonable maturity date that fits your needs appropriately.
Universal Life Insurance Pros and Cons
As mentioned previously, universal life insurance is similar to whole life in that they are both forms of permanent coverage. The key differences include that the cash value for a whole life policy grows at a fixed rate of interest and the premiums are fixed for the life of the policy.
Universal life insurance plans have a greater potential for gain since the cash value can grow at a faster rate, provided the insurer’s portfolio is performing well. However, if the market performs poorly, the rate of interest for the cash value on a universal policy would be lower than a whole life policy. Additionally, during these low periods of interest rates, or as you grow older, your carrier is more than likely to increase the cost of your coverage. With whole life insurance policies, your premiums remain level so you’ll know what you are paying at any point to keep your coverage in force.
One last thing – the policy that you do choose should meet your financial needs, as well as your appetite for risk. For individuals that prefer an investment product as part of their life insurance policy, the better financial decision long-term is a universal life insurance policy.