The pros and cons of Universal Life Insurance
An in-depth overview of Universal Life Insurance (Skip to the brief overview for a more general description)
Universal Life Insurance, also called “Flexible Premium Adjustable Life Insurance,” is a more flexible version of Whole Life Insurance. Like Whole Life, Universal Life Insurance features a savings element that grows on a tax-deferred basis. A portion of your premiums are invested by the insurance company in bonds, mortgages and money market funds. The return on the investments is credited to your policy tax-deferred. A guaranteed minimum interest rate applied to the policy (usually around 4%) means that if the investments perform well, you can earn more than the minimum rate, but it can never fall below the minimum rate. Universal Life allows you to choose from two death benefit options. Option A pays the death benefit out of the policy’s cash value; the more cash value you build up means the company is on the hook for less insurance (and therefore costs less). Option B pays the face amount stated in the contract, plus any cash values you accumulated over the years (costs more). Many Universal Life Insurance policies today offer a no-lapse guarantee: as long as you pay the minimum designated premium, the policy will stay in force to age 100 (usually). However, the minimum guaranteed premium is rarely sufficient to build up significant cash values.
Universal life insurance is very flexible with its premium payments. Under a Universal Life Insurance Policy, the policy owner has complete freedom concerning how much premium to pay and when to pay it. If the policyowner wants to reduce the premium for a whole life insurance policy, it is necessary to reduce the face value of the policy through a partial surrender of the policy. Unfortunately, this can result in the release of cash value to the policyowner and possible income tax liability. Universal life insurance policies unlock the connection between premium, face amount and cash value.
Despite the premium flexibility, of universal life insurance, there are certain rules that apply to premium payments. Although a policyowner may choose to pay no premium into the policy on a particular premium-due date, any payments that are made must meet a certain minimum to help the carrier to manage the costs of premium collection and processing.
The universal life insurance target premium is generally the amount of premium that will keep the policy in force for the insured’s lifetime. There is, however, no guarantee that the universal life insurance policy will remain in force for that period if only the target premium is paid. In fact, there is no guarantee that the universal life insurance policy will remain in force regardless of the premium level that is maintained by the policy owner.
The maximum premium is the largest permitted premium that will enable the universal life insurance policy to maintain its character as life insurance. If you pay additional premiums, then the policy will be considered a “Modified Endowment Contract” or MEC. MECs lose much of the tax advantages of life insurance.
No Lapse Guaranteed Universal Life Insurance Policies have a defined premium level at which the carrier guarantees that the policy will remain in force even if the cash value should dip below zero and the policy would otherwise lapse.
A Brief Overview of Universal Life Insurance:
Universal Life Insurance is a more flexible version of Whole Life Insurance. Universal policies offer flexible premium payments, cash value, and death benefits. These three aspects of the policy can be changed to meet the policyowner’s needs at any point in time.
You can choose to use the cash value of the policy to pay your premiums (option A) or the cash value can be added to the death benefit (option B). Option A is less expensive but option B provides more benefits.
Pros:
Universal Life gives you the flexibility to adjust the death benefit as your needs change, as well as the flexibility to pay smaller or larger premiums – depending on your financial circumstances. This is often an important feature for families who may have fluctuations in their ability to pay.
Cons:
If your premium payments are too small for too long, the policy could lapse, leaving you without insurance protection. Also, if the insurance company does poorly with its investments, the interest return on the cash portion of the policy will decrease (but never below the minimum interest rate guaranteed in the contract). In this case, cash values will probably fall, forcing you to pay more premium in the later years.