Why Do I Need Universal Life Insurance?

Universal Life Insurance: The Basics

Universal life insurance is a form of permanent life insurance that allows for cash value accumulation. Unlike most other forms of life insurance, universal life insurance includes a savings account that can either increase or decrease in value; it’s a hybrid between traditional investment and a life insurance policy. Most of the time, we think of the stock market or mutual funds when we think about investment. But universal life insurance offers a unique, tax-deferred investment method.

Permanent life insurance policies are plans that do not expire after a set amount of time. Unlike other permanent life insurance policies, universal life insurance has an added cash value component and cheaper insurance premiums. 

Universal policies are one of the most flexible types of life insurance, as you can increase, decrease, or even stop the premium and the death benefit over time. This flexibility to adjust your payments as your life circumstances change or alter is one of this policy type’s main advantages. 

However, one disadvantage of this flexibility is that your minimum premium (also known as the cost of insurance) will increase over time as you age, as we’ll cover in more detail later on.

How Does Universal Life Insurance Work?

Universal policy premiums include two components: the cost of insurance amount and the savings component amount, also known as the cash value.

The cost of insurance (COI) is the minimum amount you must pay to keep your policy active. This amount varies based on your age, health, and insured risk amount. In universal life insurance policies, the cost of insurance usually increases as you age. This differs from whole life policies, in which the policyholder pays a fixed premium for their entire life. 

In a universal life policy, any amount of money you pay above the COI goes into the savings component, an investment account. The interest you earn grows and is tax-deferred, increasing the cash value of the policy.

Pros and Cons of Universal Life Insurance

As with all types of life insurance policies, universal life insurance has both financial strengths and weaknesses. And its benefits will vary from customer to customer. Because each policyholder has a unique life and financial situation, universal life insurance’s disadvantages might be prohibitive for some but less critical for others.

Pros

1. Guaranteed death benefit: As with all life insurance policies, if you die while the policy is active. The insurance company will pay out a tax-free, no-strings-attached death benefit to your beneficiaries. This means that your heirs will not have to pay income tax on the money and can use their benefit amount for whatever they may need, whether that’s funeral costs, college tuition, or long-term care for a widowed spouse. 
   • One thing to note: if you’ve made the beneficiary of your policy an estate, rather than an individual, then the person or people inheriting that estate might have to pay estate taxes.
2. Flexible premiums: Though there is a minimum amount you have to pay for your universal life insurance (the cost of insurance), you have the option to pay more in times of financial success. This additional money goes into the savings component and allows you to build cash value. Conversely, you can also pay less during times of hardship. 
   • Some universal life insurance policies will allow you to stop paying your premiums altogether––for a certain length of time. However, you should speak with your insurance agent about whether this applies to your specific policy before stopping your payments. That way, you’ll avoid dangerous policy lapses and potentially losing your lifetime coverage! 
3. Savings component: By contributing excess money above and beyond your basic premium when you’re able. You can grow your savings component, which grows interest and provides collateral. That you can borrow against with tax-free policy loans. Some people use their universal life insurance as an alternative to a 401k or other retirement accounts.
4. Tax-deferred growth: The interest your savings accrue is income tax-free until you withdraw it. This means that the account can increase in value faster than if you had to pay taxes on the interest.

Cons

1. Variable premiums: Unlike whole life insurance policies, which have fixed premium payments. Universal life policies have variable premiums that increase as you age. Given that most people rely on a fixed source of retirement income. The increasing premiums can end up becoming a severe financial hardship and causing lapses in coverage when it’s needed most.
2. Fees: Though the savings component is an attractive facet of universal life insurance policies. Withdrawing money from that account can come with fees attached. If you try and withdraw your cash value early, you may be subject to surrender charges. 
   • The surrender value is the difference between your cash value and any possible surrender charges. Surrender charges are typically no longer in effect after 10 to 15 years for a universal life insurance policy.
3. Interest rates: Because the life insurance company wants to demotivate you from taking out loans against your policy, interest rates can be particularly high. Most life insurance providers charge rates of five to nine percent, in addition to the flat fees you’ll need to pay to take out a loan in the first place.
4. Savings component not included in death benefit: If you don’t withdraw all the money in your savings component. Before you pass away, it’s not included with the death benefit payout to your beneficiaries. The insurance company keeps any money in the savings portion of your policy.