Anytime individuals search for permanent life insurance, they usually think only of Whole Life insurance; nevertheless, another kind of permanent coverage is Universal Life (UL). UL is less costly than Whole Life and, when set up correctly, will protect you for a lifetime and offer added benefits while you are living as well.This article deals with what is universal life insurance and what makes it different.
By definition, a Universal Life Insurance policy is a cash value life insurance policy that includes the reduced cost of Term Life Insurance with the savings methods and lifetime insurance coverage of Whole Life. It is commonly referred to as a “flexible” policy simply because both the policyholder and the insurance company can make modifications to it. Then again, when correctly designed, it is extremely rare that the insurance company will need to make any changes.
Universal Life: What is Universal Life Insurance and How Does it Work?
A Universal Life insurance policy has two separate accounts – a savings account and a life insurance account. Each month (each billing cycle), an individual’s premium plus the specified interest goes into the savings account. At the same time, the insurance company will transfer money into the insurance account to pay for the expense of insurance as well as any related fees (administrative costs).
As the policyholder gets older, the cost of insurance goes up; however, if you fund the policy correctly in the early years of the policy, you will have adequate savings built up to keep up with rising costs and will typically never need to raise your periodic premium.
Universal life insurance premiums can be arranged in one of three different ways. The “minimum” premium is the least amount you could pay and will basically pay the insurance cost for fifteen years. Subsequently, the policyholder would need to raise your periodic premium to keep the insurance in force. The other option is to pay the “modal premium,” which is the premium amount that the policyholder would have to pay to keep your savings growing until age 100.
At that point in time, the policyholder could either cash out or surrender the policy or simply allow the accumulated savings to pay the premium; you would have insurance to age 121 with no additional premium. Between these two options is the “Target” premium. This premium amount would be guaranteed to keep the policy funded for about 30 years, depending on an individual’s age at the time of the policy purchase. In the majority cases, it’s better to pay the Modal premium, which will be higher than a Term premium, but yet lower priced than Whole Life insurance.
The Guarantee Illustration
Each universal life insurance quote and policy comes with an “illustration” which shows the “guaranteed growth” and maturity point, as well as the “non-guaranteed” estimate. The mandatory phrasing of the illustration can often times be a little confusing; the “guarantee” column in the illustration is actually indicating not what the policy will do, but rather the worst possible scenario the insurance policy could have if the insurance company decreased the interest rate to the minimum allowable by law and at the same time raised the cost of insurance to the highest rate allowable by law.
A good life insurance company would likely not do that but are forced by law to demonstrate this “worst case” scenario. The non-guaranteed illustration demonstrates the projected performance of the insurance contract depending on current interest rates and insurance costs together with the assumption that the policyholder will not withdraw the accumulated cash from the savings account or change the intended periodic premium.
Pros and Cons
A universal life insurance policy is considered a flexible policy because you can adjust your premium, increase or decrease the death benefit, and withdraw cash from the savings account in the for any reason. This is advantageous because if you were suddenly unable to pay the periodic premium due to an unexpected financial emergency situation, you could reduce your periodic premium to the minimum payment required and keep the insurance coverage in force for a few additional years until your circumstances improved. You can also take out cash from the savings account or borrow against it.
The positive aspects of a Universal Life insurance policy can also become the negatives. It can be seductive to pay a very low premium for too long or to simply take too much money out of the savings account and end up having to raise the premium amount to cover the cost of the life insurance. Then again, if you treat the insurance policy like a whole life policy and only make adjustments to it when absolutely necessary, you will have reliable coverage at an affordable cost for your entire life.
Similar to Whole Life and Term Insurance, most Universal Life Insurance policies allow the policyholder to add optional coverages (riders) that will enhance the policy’s benefits. For example, the Accelerated Death Benefit rider provides for the insurance company to pay a large portion of the death benefit in advance to the policyholder if they or diagnosed with a terminal illness.
This benefit, which helps the policyholder take care of the costs associated with a terminal illness is paid on a tax-free basis and does not have to be paid back. The amount that is paid in advance to the policyholder is simply deducted from the remaining death benefit when the policyholder dies.
Similar to Term Insurance, the insurance company will also make riders such as Child Term Rider, Additional Insured Rider, and Accidental Death benefit available to the applicant, allowing for additional benefits to be added to the coverage.