Universal Life Insurance
If you’re currently shopping around for a new life insurance policy or even doing a little research on some of the different available coverage options, then it’s very likely you’ve come across one option called universal life insurance.
Universal life insurance is a popular permanent life insurance option but it can be a bit confusing. One reason it can be confusing is because of the different variations that it comes available in.
The article below will discuss in detail what exactly universal life insurance is, how it works, the various options, and their pros and cons.
We hope you enjoy the article and please be sure to reach out to us with questions or requests for quotes.
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What is Universal Life Insurance?
Before we get into the details as to what a universal life insurance policy is, it’s important to understand that it is not whole life insurance. Universal life insurance and whole life insurance are commonly mistaken for being the same and although they have similarities they are different in many ways.
The two biggest similarities are that they both provide permanent life insurance protection along with cash value growth potential. In fact, this is often the reason why the two coverage options are mistaken for being the same coverage.
However, the biggest differences between the two permanent life insurance options are within their flexibility to the insured.
Universal life insurance allows for premium payments, as well as the death benefit, to be adjusted based on changing insurance needs. Whole life insurance does not offer this. For example, any potential cash build up within the policy can be used to pay premium payments in place of regular scheduled premiums. This is assuming that there is enough built up cash within the policy.
Some universal life insurance policies will also allow for changes in the death benefit, such as increases or even decreases if needed. In addition, universal life insurance is much more affordable than whole life insurance policy.
Lastly, whole life insurance does have its advantages. Outside of it being permanent life insurance coverage there is the potential to grow higher cash values than a universal life insurance policy can offer. Whole life insurance has both guaranteed cash values as well as the potential to earn dividends.
What’s the definition of universal life insurance?
In short, a universal life insurance policy is a form of permanent life insurance coverage that provides the flexibility to adjust premiums, death benefit and build potential cash build value growth.
What are the Different Types of Universal Life Insurance?
Now that we covered what the basics are and how it is different from a whole life insurance policy, we can discuss some of the different available types.
Universal life insurance is available in three different variations:
- Traditional Universal Life Insurance (UL)
- Guaranteed Universal Life Insurance (GUL)
- Indexed Universal Life Insurance (IUL)
The biggest question for you will be deciding on which of these three variations will be the best universal life insurance policy based on your own life insurance needs and goals.
One important thing to remember is that with all three variations, each allow for flexibility as well as can provide permanent life insurance protection. These are two factors that all three options have in common.
Traditional Universal Life Insurance
Up until the early 2000’s, traditional universal life insurance was one of the main forms of universal life insurance coverage. As time has gone by, newer forms have appeared often making them a better choice than purchasing a traditional universal life insurance policy.
Traditional universal life insurance, which is also known as “UL” or current assumption and more recently referred to as non-guaranteed, is your most common form of universal life insurance.
As we touched on earlier, the life insurance is designed to be a form of permanent coverage with the flexibility to adjust both your premiums as well as the death benefit if needed.
In addition to flexibility, there is also the potential to earn tax-deferred cash growth. The cash value growth can eventually be accessed through the use of policy loans or even partial surrenders if needed.
Universal life insurance works in which a portion of your premium goes towards paying the actual cost of the insurance and then the remaining portion going towards a cash value account. The cash value account grows based on an in interest rate declared by the insurance company. Interest rates often have a guaranteed minimum usually around 2%.
The problem with traditional universal life insurance
The biggest problem with traditional universal life insurance is that your rates are not guaranteed to remain the same. Most quotes and illustration will show the insurance coverage performing for a lifetime but it’s often based on non-guaranteed projections.
A change within the interest rates or a rise in the actual cost of insurance can disrupt the insurance all together. For example, cash growth within a universal life insurance policy is important as it can be used to help keep the life insurance premiums level as the cost of insurance rises with age. Since interest rates are so low it’s often difficult to accumulate a large portion of cash value growth.
As the cost of insurance increases with age, you could run the chance of having to either adjust your premium payments to match the current cost of the insurance or have the difference from what your currently pay taken from the cash value.
If you do this, after time, your cash growth could be entirely consumed by the rise of the cost of insurance eating away at all cash value. If this happens you would need to adjust your premiums to stay inline with what the current cost of insurance is year after year. This can become very costly especially in your senior years when it would most likely happen.
Pros & Cons of Traditional Universal Life Insurance
- Allows for changes in both premium and death benefit
- Potential cash value growth
- Can borrow from the cash value
- Coverage can last a lifetime
- Coverage is not guaranteed
- If you borrow you need to repay the cash
- Could become very expensive later in life
- Not likely to gain large cash values
Guaranteed Universal Life Insurance
Guaranteed universal life insurance or GUL for short is the newer and much improved form of universal life insurance that was introduced in the early 2000’s.
This type of life insurance is the complete opposite of traditional universal life insurance as it provides several guarantees. For starters, guaranteed universal life insurance has a fixed premium that is guaranteed never change. Regardless of the cash value or cost of insurance, your premium will remain the same price for the length of the contract.
The standard contract duration is generally pay to age 121 but depending on the insurance company you can find options such as pay to age 85, 90, 95, 100, 105, 110, 115 and 120.
One of the biggest features to guaranteed universal life insurance is the no lapse protection. This feature guarantees that your life insurance policy will not lapse even if the life insurance policy has no accumulated cash value provided you pay your premiums on time.
Guaranteed universal life insurance is often considered to be one of the best types of permanent life insurance. It’s much more affordable than a whole life insurance policy and it doesn’t have many confusing components behind the coverage. The only thing you really need to remember is to make your premium payments on time.
Also, many companies offer additional features, as well as policy riders, to really enhance the overall life insurance coverage. Some of these features and riders include long term care, living benefits and even return of premium if you decide you no longer need the life insurance coverage later in life.
Are there any drawbacks to guaranteed universal life insurance?
If cash value growth is an objective in your life insurance planning, then guaranteed universal life insurance is not the coverage you want. This type of life insurance coverage is not designed for cash growth. In fact, it gains very little to no cash value at all.
The main focus with guaranteed universal life insurance is permanent life insurance protection at an affordable price.
If cash value is an objective then let’s move onto indexed universal life insurance.
Pros & Cons of Guaranteed Universal Life Insurance
- Guaranteed fixed premium
- Guaranteed death benefit
- No lapse protection
- Several optional contract durations
- Affordable permanent life insurance solution
- Very little to zero cash growth potential
- Premiums not as flexible and need to be paid on time
Indexed Universal Life Insurance
Our last type of universal life insurance is called indexed universal life insurance or IUL for short. Indexed universal life insurance is the newest type of universal life insurance and has become very popular.
This type of coverage has several of the same similarities of a traditional universal life insurance, such as flexibility with both premiums and death benefit.
The biggest difference however, is that an indexed universal life insurance policy has a much greater potential to earn higher cash values than a traditional universal life insurance policy.
Indexed universal life insurance can be a bit confusing, as well as misunderstood. This confusion often comes with how the life insurance policy earns its cash values.
With an indexed universal life insurance policy there are two ways for cash to accumulate within the policy. One method is through a fixed interest account and the other is through an indexed account.
The fixed interest account allows for cash to grow at a specific interest rate that is determined by the life insurance company. The indexed account builds cash based on the performance of popular stock market indexes such as the S&P 500, NASDAQ 100, Russell 2000, Hang Seng and EURO STOXX 50.
How does an indexed universal life insurance policy work?
With any permanent life insurance policy that cash value potential, a portion of your premium payment goes towards the actual cost of insurance with the remaining portion going towards the cash value account.
Since an indexed universal life insurance policy has both a fixed and an indexed account, you get to choose where that remaining portion of premium gets invested. You can invest it into the fixed account, the indexed account or even both.
The fixed account has the ability to grow cash values that are based off an interest rate determined by the insurance company. These rates are generally not too high and can fluctuate. On the plus side they do have a guaranteed minimum.
The indexed account has the greatest potential to earn cash growth, as the interest rate is determined based on the performance of specific stock market indexes.
If the stock market index performs well, the credited interest will be higher resulting in an increase in the cash value. It is important to know that there is generally a cap on the amount of interest the policy can earn.
The insurance company sets the cap on the maximum amount of interest that can be earned.
On the other hand, if the indexes perform poorly, your interest rate will go down. However, one of the best features to any indexed universal life insurance policy is what is called the floor.
The floor is a guaranteed minimum interest rate that set by the insurance company that protects your cash value due to negative index performance.
In addition to greater cash value gains and protection against poor index performances, an indexed universal life insurance can also offer several great policy riders.
Pros & Cons of Indexed Universal Life Insurance
- Flexible death benefit and premium payments
- Greater potential for higher cash value growth
- Protection from negative index years
- Can borrow from the cash value
- Coverage can last a lifetime
- Caps on the amount of cash growth that can be made
- Could require more premium later in life
- Coverage is not guaranteed to last forever
Cash Value Life Insurance
To better understand which type of universal life insurance is best for your needs, it helps to understand exactly what the investment portion of the policy is all about and what is meant by cash value.
The cash value of a life insurance policy acts much like a savings account by earning interest. In a universal life insurance policy, the interest earned is based on either the insurance company, current market rate or minimum interests rate whichever is greater.
While the cash value of a life insurance can be used to help supplement retirement income, saved as money for home repairs, or any other major purchase, it is important to note that that in most cases the beneficiary of the policy does not get the cash value upon the death of the policyholder.
The cash value will revert back to the insurance company and the beneficiary will only receive the total amount of the death benefit.
One of the greatest benefits of cash value life insurance is the tax-deferred growth. However, cash values can become taxable if your cash value growth is higher than what you have invested into the life insurance policy. The taxable portion is the profit that is greater than the amount of total paid premiums into the life insurance policy. This would only occur if you decided to surrender the policy and showed a gain.
When it comes to policy loans it is also important to know that you will need to repay the money taken. You will also be charged an annual interest rate on the loan amount. If you don’t pay the interest rate it will be deducted from any remaining cash balance within the life insurance policy. Should a policyholder pass away while there is an outstanding loan, the balance will be deducted from the death benefit prior to being paid out to the beneficiary.
What’s the Best Universal Life Insurance Policy?
No matter the type of life insurance policy you choose, it is important to research your options in order to make the best choice that meets your needs.
With regards to the actual available types of universal life insurance coverage, they each have their own pros as well as cons.
A guaranteed universal life insurance policy is your safest option if your main concern is having a permanent coverage at an affordable price. Again, don’t expect to make any cash but rest assure you wont need to worry about any changes being made to the premiums especially later in life.
If you like the idea of life insurance with potential cash values, I would recommend the indexed universal life over the traditional. However, understand that neither of these cash value options offer the guarantee that they will not require additional premium later in life, should they not perform as projected. This is something that really needs to be taken into account when considering a cash value universal life insurance policy.
For more information or questions pertaining to life insurance products or quotes, please be sure to reach out to us for assistance. Top Quote Life Insurance is an independent life insurance agency that can provide both life insurance products as well as quotes from dozens of the top rated insurance companies.