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What Is Universal Life Insurance?


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Elizabeth Rivelli
Updated March 13, 2022
4 Min Read

Life insurance is typically used to financially support your loved ones after you pass away. Certain policies can also supplement your income during retirement, allow you to leave money to heirs, and pay for your end-of-life expenses.

There are two basic kinds of life insurance—term life insurance, which offers coverage for a certain number of years, and permanent life insurance, which offers protection for your lifetime. Under the permanent life insurance umbrella, there are several types of policies, one of which is universal life insurance.

Universal life insurance is a permanent life insurance policy that has a death benefit and a cash value component that grows with interest. Unlike other types of permanent life insurance, universal life insurance has flexible premiums and an adjustable death benefit that you can change based on your family’s financial needs.

How does universal life insurance work?

When you purchase a universal life insurance policy, you choose a coverage limit, called the death benefit, which is the amount of money that your beneficiaries receive when you pass away. You also pay a monthly or annual premium that keeps your policy in force.

When you pay the premium, a portion of the money goes towards the policy’s cash value, which is similar to a savings account. With universal life insurance, the money from your cash value gets invested into the stock market, and grows with interest based on the market’s performance.

Once your cash value balance reaches a certain amount, you have the option to borrow the money as a personal loan, which can be used for any purpose. You can also use the funds from your cash value to cover the cost of your premium, or lower the amount you pay out-of-pocket.

Another unique aspect of universal life insurance is that it has an adjustable death benefit. You can increase or decrease the amount of coverage at any time based on your family’s financial circumstances. However, you’ll need to pass a medical exam if you want to buy more coverage.

Types of universal life insurance

There are three types of universal life insurance—indexed universal, variable universal, and guaranteed universal. Each policy offers permanent coverage with a cash value component, and the main difference is how the cash value is invested. Here’s a look at each type of coverage:

  • Indexed universal life insurance: With indexed universal life insurance, the cash value is invested in an index, such as the S&P 500 or Nasdaq. If the fund goes up, your cash value grows. If the market is down, your cash value will likely go down with it, and your premium could increase as a result.
  • Variable universal life insurance: With variable universal life insurance, your cash value is invested in a mutual fund, which is a portfolio that is managed by investment professionals. Mutual funds are a good way to diversify your investments, and like all types of universal life insurance, your cash value is affected by market performance.
  • Guaranteed universal life insurance: With guaranteed universal life insurance, your cash value is invested in a stock market index, but your premium is guaranteed to stay the same regardless of market performance. The insurance company guarantees a certain interest rate, so it’s a less risky investment.

Whole life vs. universal life insurance

Whole life insurance is another permanent life insurance policy that builds cash value overtime. At a certain point, you are allowed to borrow some or all of the cash value you’ve accumulated, and pay interest as you would with a standard personal loan. However, whole life insurance and universal life insurance have a few key differences.

First, whole life insurance premiums are almost always fixed. Regardless of how much cash value your policy has, most insurance companies will not allow you to use the funds to lower your premium. Similarly, whole life insurance doesn’t have an adjustable death benefit. The amount of coverage you purchase will remain constant throughout the duration of your policy.

What are the benefits of universal life insurance?

There are a handful of benefits to purchasing universal life insurance, the main one being that the death benefit is flexible. If you purchase coverage at 40, there’s a good chance that your family’s financial needs will have changed by the time you turn 80. Universal life insurance allows you to increase or decrease your coverage limits accordingly.

Another benefit is that you can use cash value to your advantage. If you use the money to cover your premium, it can reduce your monthly bills. If you need access to money quickly, you also have the option to borrow money from your cash value, and use it to pay for your child’s college tuition, put a down payment on a home, cover unexpected medical bills, or however you want.

What are the disadvantages of universal life insurance?

Universal life insurance has some major downsides that you should consider before buying a policy. First, these policies tend to be very expensive. If you buy universal life insurance, expect to pay a hefty premium, even for a moderate amount of coverage.

If you borrow the cash value as a loan, it’s not free money. You will pay interest on the amount you borrowed, and the rate will probably be much higher than it would be if you took out a standard personal loan from a bank or traditional lender.

Additionally, most financial advisors will recommend against using universal life insurance as an investment strategy. These policies usually have extremely high administrative fees, which can significantly impact your gains.

Another thing to consider is that most insurance companies cap your participation rate, meaning that even during a strong market year, your cash value can only earn so much interest. Plus, if the market performs badly, your cash value will diminish.

Is universal life insurance right for you?

If you are thinking about purchasing universal life insurance, know that it’s not a good choice for everyone. This type of life insurance is best for individuals who are already comfortable with investing, and are looking to diversify their portfolio.

Ultimately, universal life insurance is not a great option for anyone. The cash value, flexible premiums, and growth potential can be attractive, but in reality, universal life insurance has more downsides than upsides. The policies are extremely expensive, and you will likely see greater returns on your money by investing elsewhere.

If you are looking for permanent life insurance, a whole life insurance policy is a much better alternative. The policies have less flexibility, but the premiums and administrative fees are significantly cheaper. Additionally, you might consider term life insurance, which offers limited coverage and doesn’t have cash value, but will always have the lowest rates.