Universal Life Insurance

Key takeaways
* Universal life (UL) is a form of permanent life insurance that combines a death benefit with a cash-value savings component.
* Premiums and (in many policies) the death benefit are flexible within policy limits.
* Cash value earns interest set by the insurer (often with a minimum rate); poor performance or underfunding can lead to higher premiums or policy lapse.
* Policy loans are generally tax-free, but some withdrawals can be taxable; unpaid loans reduce the death benefit.

What is universal life insurance?

Universal life is permanent life insurance that remains in force for the insured’s lifetime as long as required premiums are paid. It differs from term insurance by including a cash-value account that accumulates interest and can be accessed through loans or withdrawals. Compared with whole life, UL typically offers more flexibility in premiums and interest-crediting but usually does not guarantee a fixed interest rate.

How it works

• Premium components:
• Cost of insurance (COI) — the part of each premium that covers mortality and policy charges; COI typically increases as the insured ages.
• Cash value — any premium paid beyond COI is credited to the policy’s cash-value account and earns interest.
• Flexibility:
• You can often raise or lower premium payments within policy limits. Paying more builds cash value; paying less can draw from cash value to cover COI.
• Some policies allow adjusting the death benefit (increases may require underwriting).
• Interest and performance:
• The insurer sets the interest rate on the cash value; it can change over time but often includes a stated minimum.
• Accessing value:
• Policy loans: Typically tax-free while the policy remains in force; unpaid loan balances and interest reduce the death benefit.
• Withdrawals: Generally follow a first-in, first-out (FIFO) approach — withdrawals up to the premiums paid (basis) are usually tax-free; amounts that represent gain may be taxable.
• Lapse risk:
• If cash value is depleted and premiums don’t cover COI, the policy can lapse unless additional payments are made.

Advantages

• Flexible premiums and death benefit options.
• Potential to accumulate cash value that can be borrowed against or withdrawn.
• Loan interest rates often competitive and loans usually don’t require a credit check.
• Can be less expensive than whole life initially because interest rates aren’t guaranteed.

Disadvantages

• Returns on cash value are not guaranteed — interest-crediting can fall when rates decline.
• Management required: you must monitor cash value and COI increases to avoid underfunding or lapse.
• Withdrawals above basis are taxable.
• Cash value typically remains with the insurer at death unless the policy’s death benefit option includes the cash value; beneficiaries generally receive only the death benefit.
• If underfunded, premiums can spike later in life.

Universal life vs. term vs. whole

• Term life:
• Provides coverage for a specified period (e.g., 10, 20, 30 years).
• Lowest premiums, no cash-value accumulation, no payout if you outlive the term.
• Whole life:
• Permanent coverage with fixed premiums, guaranteed death benefit, and guaranteed (or more predictable) cash value growth.
• Generally higher premiums but more stability and guarantees.
• Universal life:
• Permanent coverage with flexible premiums and adjustable death benefit options.
• Cash value growth depends on insurer-set interest rates (often with a minimum); more flexible but less predictably guaranteed than whole life.

Variants

• Indexed universal life (IUL): Cash value growth tied to a stock index performance with caps/floors.
• Variable universal life (VUL): Cash value is invested in subaccounts (like mutual funds), exposing value to market fluctuations and investment risk.

Common questions

Q: Can I cash out my UL policy?
A: Yes — you can surrender the policy and receive the cash-surrender value (minus surrender charges if applicable). Surrenders may be taxable on any gain.

Q: Are policy loans taxable?
A: Generally no, as long as the policy remains in force. However, if the policy lapses or is surrendered with an outstanding loan, tax consequences may apply.

Q: What happens to the cash value when the insured dies?
A: Typically the insurer keeps the cash value and pays the beneficiary the death benefit. Some policies offer a death benefit option that includes the cash value.

Q: Which is better, whole life or universal life?
A: It depends on priorities. Choose whole life for guaranteed growth, fixed premiums, and stability. Choose universal life if you value premium flexibility and are comfortable managing cash-value performance and lapse risk.

Bottom line

Universal life insurance offers permanent coverage with flexible premiums and a cash-value savings component, making it attractive for those who want flexibility and access to policy funds. That flexibility comes with responsibilities: cash-value performance and rising COI with age mean you must monitor funding to avoid larger future premiums or policy lapse. Understand the policy’s interest-crediting method, minimum guarantees, loan rules, and any surrender charges before purchasing.