How does universal life insurance work? by Jerry C. Thomas, CFP®

Learn how universal life insurance works, the different types of universal life insurance policies available, and examples on how it works.

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Transcript:
How does universal life insurance work?

Universal life insurance is a type of permanent life insurance. It is different from term insurance, which only provides coverage for a specific period of time. Universal life insurance is intended to last your entire life.

In addition to providing a death benefit, a universal life policy consists of two components:
1)The cost of insurance which includes mortality costs, policy administration, and expenses, and
2) A savings component called the cash value.

Policy owners have flexibility in their premiums and death benefit. They can either pay the minimum premium required to keep the policy in-force or pay up-to the maximum premium amount to grow more cash value.

One important thing to consider is that the cost of universal life insurance starts very low and increases annually with age. If only the minimum premium is paid, the policy can become expensive since there is no cash value to offset cost of insurance requirements.

The policy owner can access the cash value while alive. This can be done by either withdrawing or borrowing against the cash value. The cash value can accumulate based on guaranteed or non-guaranteed rate. The guaranteed rate is usually 1%-2%. The non-guaranteed rate is based on the performance of a specific financial instrument and is dependent on the type of universal life policy.

There are four main types of universal life policies:
First - Current Assumption Universal Life, where cash value accumulation is based on an interest rate determined by the insurance company.

Second - Indexed Universal Life, where cash value accumulation is tied to the performance of an index fund like the S&P 500 or NASDAQ.

Third - Variable Universal Life, where performance is based on the performance of the sub-accounts which are similar to mutual funds.

And last Guaranteed Universal Life, which grows very little to no cash value and is intended to provide a low cost guaranteed death benefit for the life of the insured, some people call this “term life insurance for life.”

For example, Jane purchases a universal life policy with a required premium payment of $25 a month. Jane decides she wants to put some money away too, so she pays an additional $50 each month that goes into the cash value.

As Jane gets older the cost of insurance portion of the policy increases, meaning less of her $75 monthly premium goes into the cash value account. Since she paid more in the early years of the policy, Jane has accumulated cash value.

Jane can either utilize the cash value to pay a portion of the premium, or she can withdraw or borrow against her universal life policy to pay expenses.

If you plan to make a withdrawal or loan from your cash value, you will want to conduct a policy review, to make sure the policy can withstand these changes.

Universal life premiums are typically more expensive than term life but will be less expensive than whole life insurance.

If considering universal life insurance, we highly recommend reviewing multiple options and understanding the advantages and disadvantages before purchasing.