Universal life insurance, a form of permanent coverage similar to other permanent policies, incorporates a cash value aspect. In addition, this insurance guarantees the best lifetime protection possible with regular premium payments.
Compared to whole life insurance, these policies grant flexibility in adjusting premiums within set boundaries and may come at a minimal expense. However, inadequate investment performance or prolonged underpayment may influence the death benefit or lead to policy termination.
Borrowing against the significant cash value of a Universal Life policy doesn’t carry tax implications for policyholders. Moreover, certain withdrawals from the policy may be subject to taxation.
How Does it work?
Adjustable life insurance, also referred to as universal life insurance, separates itself by allowing policyholders to modify their premium payments. Typically, these advantageous options are for those with fluctuating cash flows.
Additionally, it provides the flexibility to adjust the death benefit amount. This feature enables policyholders to decrease the death benefit if their need for coverage diminishes over time or potentially increases it.
Furthermore, this insurance can provide lifelong coverage, provided that premium payments are maintained. Typically, it includes a cash value component, from which funds can be accessed through withdrawals or policy loans.
Surrendering a universal life insurance policy terminates coverage, and the policyholder receives the cash value, minus surrender charges.
Types of Universal Life Insurance
Consider three alternative types of universal life insurance policies.
Guaranteed Universal Life Insurance
It provides a more hands-off approach compared to standard universal life insurance. Positioned as a middle ground between term and whole life insurance, it entails lower rates due to minimal cash value growth.
Indexed Universal Life Insurance
It functions similarly to its standard counterpart, but its cash value hinges on the performance of stock indexes like the S&P 500 and Nasdaq composite. Unless alternative investments are specified, the cash value may be directed to a fixed account.
Variable Universal Life Insurance
It allocates a portion of its cash value to diverse subaccounts of your choosing. With greater potential returns and losses, it carries increased risk compared to other types of insurance.
Advantages and Disadvantages of Universal Life Insurance
Aside from providing permanent insurance, universal life insurance includes several additional features, which include:
Advantages
Flexible Premiums
Unlike whole life insurance plans with fixed premiums throughout the policy’s duration, this policy typically offers flexible premium options within certain limits. In addition, policyholders can choose to make payments exceeding the cost of insurance (COI).
However, any surplus premium is added to the cash value and accrues interest. Furthermore, if there is sufficient cash value, policyholders may reduce or skip payments without risking a policy lapse.
Possible Flexible Death Benefit
Your insurance could be enhanced in size, although a medical examination may be necessary for such adjustments. Additionally, you may have the option to decrease the death benefit to reduce your premium payments.
Significant Cash Value Growth
A universal life insurance policy can amass cash value, functioning as a savings account similar to other permanent life insurance. The cash value earns interest is determined by either the existing market rate or the policy’s minimum interest rate, with the higher of the two applied.
Additionally, as this value grows, policyholders have the option to make partial withdrawals or take out loans against the collected cash value.
Policy Loans
Universal Life policyholders have the option to borrow against the accumulated cash value without incurring tax implications. These loans typically carry lower interest rates compared to personal loans and do not necessitate a credit check.
It’s important to note that any outstanding and unpaid loans will result in a reduction of the death benefit by the corresponding amount.
Disadvantages
Risk of a Significant Payment Requirement or Policy Lapse
Despite the flexibility offered by this insurance, including the capacity to reduce premiums and make withdrawals in times of necessity, it’s crucial to monitor your account diligently. If the cash value reaches zero and your premiums fail to cover the cost of insurance, there’s a risk of a policy lapse.
Returns are not Guaranteed
In the event of a decline in interest rates, the performance of your cash value in a universal life insurance policy may be negatively affected. Unlike whole life insurance, the cash value of universal life policies does not accrue at a guaranteed rate.
However, many universal life policies include a minimum rate to mitigate potential losses and provide a level of protection.
Some withdrawals are Taxable
Withdrawals from the cash value of a Universal Life (UL) policy are generally taxable. The taxation follows a first-in, first-out (FIFO) method for life insurance.
Furthermore, this simply means that the policy owner will first receive their initial investment in the contract before any gains are considered or taxed. However, if the amount withdrawn exceeds the total amount paid into the policy, the excess will be subject to taxation.
Cash Value Lost at the Policyholder’s Death
Upon the death of a policyholder, the insurance company retains the cash value of the account. Beneficiaries receive only the death benefit, as the policyholder can utilize the cash value only during their lifetime.
In addition, certain life insurance policies permit a significant increase in the death benefit as the cash value increases.
Conclusion
Universal Life Insurance represents a type of permanent life insurance that incorporates an investment savings component, loan choices, and adaptable premiums. These policies offer the flexibility to adjust premiums within certain boundaries, making them potentially more economical than whole-life coverage.