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What Is Universal Life Insurance & How Does It Work?

Life Insurance
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When you purchase a life insurance policy, you're making a decision that could affect your family for years (and possibly generations) to come. Since it's impossible to predict the future, the policy you choose now might not be your best choice 10 years down the road. With a universal life policy, you could have the flexibility to adjust your coverage to suit your needs as life changes.

What Is Universal Life Insurance?

Universal life insurance is a permanent life insurance policy, and the coverage can last your entire life if it's managed correctly. Typically, when you first buy your policy, you pay enough to potentially build up cash value within the policy itself.

Then, when you're older, the accumulated cash value can sometimes make up any difference in policy costs so you don't face increased premiums. Your financial representative can tell you how much you could pay per year to effectively prepare for your later coverage.

What Are the Types of Universal Life Insurance?

There are different types of universal life insurance. Here is some information to consider.

Traditional Universal Life

In a traditional universal life insurance policy, the growth of your cash value depends on market rates, the amount of premiums paid and the cost of monthly policy charges. During years when interest rates are high, your cash value may grow more than years when rates are lower. While there is some unpredictability on the rate that will be credited, the policy will pay a minimum rate each year that's set by the insurance company. These policies may or may not have a guaranteed death benefit that will prevent policy termination based on the payment of sufficient premiums.

Indexed/Fixed Indexed Universal Life

With indexed/fixed indexed universal life insurance, you have control over how the funds in your policy are allocated between different interest-accruing accounts. If you allocate premiums to an indexed account, rather than an indexed account where a fixed rate is set by the life insurance company, the cash value will be eligible to receive any earned "indexed interest credits." Since a market index can have more changes in performance and even be negative some years, this may be riskier than traditional universal life insurance. However, the life insurance company could set limits on your maximum potential loss and gain. These policies may have a guaranteed death benefit.

Variable Universal Life

Variable universal life insurance allows you to invest the cash value in certain mutual fund securities, such as an equity or bond fund, and these are often called sub-accounts. The potential growth of the cash value is the highest of all universal policies but your risk is also higher. Depending on the policy terms, you could even potentially lose cash value during market downturns. These policies do not have a guaranteed death benefit.

Group Universal Life

Group universal life insurance is a workplace benefit offered by some employers. If available, employees have the choice to sign up for a policy at work and their employer may cover some or all the cost. Since multiple many people are signing up, the life insurance company may offer a group discount. It's up to the employer to decide what version of universal life policies are available through the group plan.

Compare Universal Life Insurance options.

What Are the Potential Advantages of Universal Life Insurance?

The design of universal life insurance gives you more control over how you manage your policy. You can change the amount you pay into the policy every year.

When you have more income, you can pay more into the policy, whereas when your budget is tight, you can reduce your premium — though only if you've ensured there's sufficient cash value to cover your monthly charges.

Some universal life insurance policies also let you change their death benefit. You can decrease to a smaller death benefit or add coverage without buying a new policy — for example, increasing from $300,000 to $400,000 (this may be subject to insurability/underwriting approval).

When Is Universal Life a Good Fit?

Universal life could work well for younger applicants who have more time to potentially build their cash value while insurance costs are low. It can also be an effective choice for applicants who want flexibility with their premiums.

Example: Let's say Andrew works as a construction worker and makes most of his money during the summer. He may like universal life because he can make large payments during the summer while reducing his premium payments during off-season months.

Universal life could also work well for people who are unsure of how much life insurance they need.

Example: If Tanya is a recent newlywed who wants children someday, for instance, she might not know just how big her family will get. She buys a $400,000 universal life policy that lets her adjust the death benefit. She may be able to increase or decrease the size of her policy once her family situation becomes clearer.

Does Universal Life Insurance Have Cash Value?

Universal life insurance can build cash value, which you could also take out and spend while you're still alive — but keep in mind doing so may generate an income tax liability, reduce the account value and the death benefit, cause the policy to lapse and incur surrender charges, which can vary depending on your age, gender and underwriting class. The growth of your cash value depends on market rates, the amount of premiums paid and the cost of monthly policy charges.

What Happens to Cash Value in a Universal Life Policy at Death?

When you die, the life insurance company does not always transfer the cash value to your beneficiaries. However, most universal life insurance policies do have a death benefit option that pays the beneficiary both the death benefit and the cash value, in addition to the option that only pays a death benefit. If you'd like to take out that cash value before your death, you can also do that, but doing so could decrease the death benefit and may incur surrender charges.

What Is the Difference Between Universal & Whole Life Insurance?

Universal and whole life insurance are both permanent policies that can last your entire life. You pay a premium, which is the amount of money you pay the life insurance company in exchange for your coverage. Some of the premium goes toward the cost of insurance, which is based on your selected face amount, your selected death benefit, your gender, your age, and any underwriting ratings assigned. The cost of insurance also covers any policy fees.

However, there are some differences between these two types of policies. First, with whole life insurance, your premium typically stays the same over the life of the policy, and with universal life insurance, you may have the flexibility to adjust your premium as long as you pay enough to cover the cost of insurance each year.

Universal life insurance is also usually less expensive when you first sign up, but then your insurance costs increase over time as you get older. You need to build enough cash value or pay enough in premiums to cover these growing costs or else you could lose your coverage. Whole life insurance is typically more expensive from the start but the premium will not increase over time.

Finally, whole life insurance has generally lower but steadier cash value growth. The life insurance company typically pays a fixed return that's partially guaranteed. With universal life insurance, your cash value return can change year after year. The cash value has the potential to grow more quickly than whole life insurance policies, but it may grow less and you may even lose cash value over time.

Can You Cash in a Universal Life Insurance Policy?

Yes, if you decide you no longer need coverage, you could cancel the policy and take the surrender value as a cash payment. The insurance company will send you a check for your cash value balance, minus any fees or outstanding loans. If you receive more cash value than you paid in total premiums for the policy, you will owe income tax on your gain.

Besides cancelling and surrendering your entire policy, another option could be to take out a loan or a withdrawal from your cash value while keeping your coverage. It's important to note, however, that loans or withdrawals may generate an income tax liability, reduce the death benefit and may cause the policy to lapse.

Important Considerations for Universal Life

With universal life, it helps to be disciplined and build your cash value at the beginning of your policy. Otherwise, you may not have enough in reserve to keep up with the higher future premiums. If this happens, you must pay more money into the policy or lose your coverage.

Also, any estimation of how much you need to pay into the policy to keep it in force will be based on a prediction of market interest rates and insurance costs. If this forecast is incorrect, you may also need to pay more than expected to keep your coverage.

If flexibility is important for your insurance policy, you might want to consider universal life insurance. In exchange for a little more effort, you could have more control over your coverage terms.

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Information provided is general and educational in nature, and all products or services discussed may not be provided by Western & Southern Financial Group or its member companies (“the Company”). The information is not intended to be, and should not be construed as, legal or tax advice. The Company does not provide legal or tax advice. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. The Company makes no warranties with regard to the information or results obtained by its use. The Company disclaims any liability arising out of your use of, or reliance on, the information. Consult an attorney or tax advisor regarding your specific legal or tax situation.