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By José Omar Rodríguez and Norma Rodríguez
Updated: June 1, 2021 10:53 AM ET | Originally published: May 7, 2021
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Money; Getty Images

Life insurance offers a variety of options to protect you and your loved ones. Permanent life insurance in the form of universal life provides permanence, flexibility, and the opportunity of having a tax-deductible cash value component in the form of an investment or savings account. Universal coverage combines the permanence of a whole life insurance policy with the affordability of term life insurance rates.

Table of Contents

What Is Universal Life Insurance?

Universal life insurance combines the protection of a term life insurance policy with the benefit of an investment or savings account. To understand how universal life insurance works, let’s take a look at term life and permanent life insurance policies:

  • Term life insurance: Provides coverage for a set period of time and guarantees a death benefit payment if the insured dies during the time of coverage.
  • Whole life insurance: Provides lifelong coverage, a death benefit payment, and an investment or savings account.
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Elements of a universal life insurance policy

  • A type of permanent life insurance
  • Coverage can last your entire life while providing cash value
  • Adjustable policy coverage and premiums
  • Cash value can be invested in securities
  • Cash value can be used to fund premium payments
  • Cash value is tax-deductible
  • The policyholder can lower the death benefit amount
  • Cash component isn’t FDIC-insured

Eligibility

Universal life insurance eligibility varies by insurer. Most insurance companies require a medical checkup. This medical exam includes a physical exam, information about prescriptions, and other questions regarding lifestyle and mental health. Insurance companies could also ask for you and your family’s medical history, access to DMV records, and your credit history.

You should never lie about your medical history, weight, or lifestyle habits on your policy application. If the insurance company finds out you lied, they can cancel your policy and deny the death benefit amount. You can also be “red-flagged” and denied coverage by other insurance companies.

Types of universal life insurance

Traditional, indexed, guaranteed, and variable universal life insurance policies provide different investments, savings, and terms to fit different needs and coverage interests.

Traditional Indexed Variable Guaranteed
Interest rates based on current market fluctuations Policyholders can invest their cash value in a fixed account or an equity-index account Allows policyholders to invest their cash value in bonds, stocks, and mutual funds Allows for premiums, benefits, and coverage amounts
Interest rates are not guaranteed Gives policyholders more control over investments Most flexible policy Permanent life insurance with the stability of a term life policy and minimal risk
If the cash account decreases, the policy could collapse Riskier than traditional life insurance Requires hands-on management Investment account accrues little cash value

Duration of coverage

Most universal life insurance products come with a “maturity date,” which could coincide with your 105th birthday or your 121st birthday. There are maturity dates that have been set as low as 85 years old, so you’ll want to read the fine print before acquiring your policy.

If you live long enough to reach your policy’s maturity date, you’ll receive a lump sum payment according to your policy’s fine print. If you pass away before the maturity date, your beneficiaries will receive the policy’s death benefit.

Death benefit

Level death benefit Increasing death benefit
Pays beneficiaries the policy’s face value while the insurer keeps the policyholder’s accrued cash value Your heirs could receive a more significant death benefit because they’d also be entitled to your policy’s cash value along with the face amount

Adding an increased death benefit will add a substantial amount to your life insurance premiums. Before the insurance company pays out benefits, it will deduct pending premium payments or debts related to loans or cash withdrawals.

How Does Universal Life Insurance Work?

Universal life has two main parts:

  • An investment account: this account starts small but should grow over time as you make regular premium payments and invest the policy’s cash value. The account could also lose value as stocks and securities decline.
  • A death benefit: the amount of money your beneficiary would receive if you died

When you buy this type of policy, your premium payments keep the death benefit in force, and they also gradually fund the investment account.

Depending on the stock market’s annual rate of return, your investment account can grow faster than it would in a traditional whole life policy’s savings component.

How to use your policy’s accumulated cash value

The accumulated cash value on your policy is tax-deferred, and as a policyholder, you can use this growth in a variety of ways, including to:

  • Pay for the policy itself: The investment account’s proceeds can fully or partially cover the policy’s payment, allowing you to have flexible premiums
  • Make withdrawals: You could withdraw money from the policy’s cash value. Different tax treatments are depending on whether you withdraw from the basis (what you paid into it) or the excess cash (what accrues over time)
  • Borrow against cash value: You can take policy loans from the investment account. However, if you don’t repay the loan with interest, the insurer deducts the amount due from the policy’s cash value. If there’s not enough cash value to cover the amount owed, the policy lapses
  • Cash out: You could cancel the coverage later in life and cash out the value of the policy. Typically you’d have to pay surrender charges and then pay income taxes on the policy’s surrender value
  • Donate: You can donate the entire policy to a charity or foundation
  • Adjust the death benefit amount: You can decrease the death benefit later in life without having to go through underwriting all over again

How much universal life insurance costs

The cost of insurance will depend on several factors: the death benefit, age, health conditions, prescription history, occupation, car accident history, lifestyle, and hobbies. Your premiums will also depend on the risk level of your profession.

As you age, you have to be aware of the possible increase in your policy’s premiums. The cash value on your account might not be enough to cover this increase, and if you don’t pay the fixed premium, your life insurance coverage can collapse.

Universal life insurance costs start at approximately $55 a month, according to Business Insider.

Underwriting process

The underwriting process starts after submitting your insurance application. Each insurance company has an underwriting manual with specific requirements for final premiums.

An underwriter will revise your application and documentation to calculate your life expectancy. To calculate your life expectancy and premiums, an underwriter will take into consideration:

  • Age and gender
  • Height and weight
  • Medical and prescription history
  • Citizenship status
  • Address
  • Tobacco use
  • Occupation and employer
  • Income
  • Other insurance policies
  • Hobbies
  • Criminal history
  • Foreign travel

Gender is considered because women have a longer life expectancy than men. Your home address is used for financial underwriting. Applicants usually submit their home as their most significant asset, and underwriters use your address to calculate your premiums.

Riders

Riders are extra benefits not included in basic life insurance policies. You can purchase riders to tailor your policy to fit your insurance needs. You can only buy riders if they’re attached to a life insurance policy, and they’re not available for purchase on their own. The most common are:

  • Waiver: The policy will remain active if you become disabled by a previously established age (around 60-65) and cannot pay for your premiums.
  • Accidental Death Benefit: Pays additional money to the beneficiaries if the insured perishes in an accident
  • Disability Income: If the insured becomes disabled, the insurance company has to provide a monthly income for as long as the disability lasts. This policy usually includes the Waver Rider.
  • Additional Insured: Provides coverage to other family members. It usually applies to a husband, wife, or children
  • Accelerated benefits: In the case of terminal illness, around-the-clock, or long-term care insurance, the insured can collect part or their full death benefit before passing.
  • Automatic Premium Loan Provision: If there is a missing payment on your policy, the insurance company will collect the payment from the cash value of your policy
  • No-lapse Guarantee: Keeps your insurance active during the no-lapse period of your policy even when the cash value drops to zero.

What can cause a claim denial

Insurance companies rarely deny life policies; however, it’s still possible. According to United Policy Holders, these are the most common reasons for claim denials:

  • The insured dies during the contestability period. Typically, the first two years after purchasing a policy
  • Type of death was not part of the policy
  • Omission of important personal information
  • Failed to pay your policy premiums

How to Buy Universal Life Insurance

When buying universal life insurance, we recommend that you seek the opinion of a professional insurance agent and a financial planner. They can guide you to find the best insurance options and cash value for your needs. Nonetheless, we also recommend that you consider our selection for the 15 Best Life Insurance Companies of 2021.

Is universal life insurance right for you?

Universal Life insurance is a suitable option for those with a higher income, those looking to have flexibility, a desire for investment, and who are not scared of taking risks.

Pros and cons of universal life insurance

Pros Cons
Your policy’s cash value depends on the market index If market rates go down, there will be little to no cash value accumulation.
You can access the cash value through withdrawals or loans without the risk of damaging your credit The policy will lapse if there isn’t enough cash value in the account and you fail to pay the premiums
The interest your account generates is tax-deferred Premiums are considerably higher than for other types of life insurance
You can change premium payments, death benefit amounts, and coverage amounts at any time You have to manage and monitor your policy

How much universal life insurance do you need?

You should select your universal life insurance policy based on your finances and how much coverage you want for yourself and your beneficiaries.

In most cases, the death benefit for your beneficiaries is tax-free, meaning the lump sum your beneficiaries will receive after your passing doesn’t count as taxable income. However, if the death benefit adds significant value to the estate, passing the annual federal estate taxes exemption of $11.7 million dollars, the beneficiary must pay taxes on it.

Many insurance companies recommend that you purchase a policy six to 10 times the amount of your salary. They also recommend that you multiply your salary by the number of years you have left before retiring.

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Universal vs. Term vs. Whole life insurance

Universal Life Insurance Term Life Insurance Whole Life Insurance
Lifetime coverage Expires after a certain period (10, 20, 30 years) Lifetime coverage
Flexibility to increase or reduce benefits Benefits only upon death Benefits available before death
You can borrow and/or withdraw from your savings component Lower premiums Savings component can be received annually, kept in an account to accumulate interest, or used to lower or cover premium payments
Higher premiums than term life insurance. However, premium payments can change depending on your needs Riskier than traditional life insurance Higher premiums than term life insurance
Can be surrendered Cannot be surrendered Can be surrendered to receive the cash value

How can you lower your premiums?

You can lower the cost of your premium by:

  • Reducing the payout amount
  • Using your cash value to pay a portion or the entirety of the policy’s monthly payment
  • Reviewing your policy regularly to see if it still meets your needs

How do you choose the right insurer?

To choose the right insurance company and policy, you should consider the following:

  • Obtain quotes from different companies, and wait until the final quote before making a decision
  • Consider financially stable companies
  • Look for available investment and other financial opportunities
  • Be upfront about your health issues
  • Research ratings and reviews

Universal life insurance and Covid-19

Universal life insurance policies cover Covid-19. Unless you lied about your recent travels to a high-risk area and exposure to illness, your policy shouldn’t be affected by the pandemic. As a result of the market fluctuation caused by Covid-19, the cash value earnings of your universal life insurance policy might have been affected. You should monitor your policy to see the changes in the market.

Also, many insurance companies are changing the requirements for an in-person medical exam, while others have waived this requirement. No exam life insurance is an option for those who are unable, or choose not to, have a physical exam.

Universal Life Insurance FAQ

What is universal life insurance?

Universal life insurance is a hybrid version of term life insurance and permanent life insurance. It provides flexible premiums and the opportunity to build cash value.

How does universal insurance work?

Universal life insurance works as whole life insurance, providing permanent coverage and access to an investment or savings account. You can use the cash value from your investments to cover monthly premiums.

What factors determine the number of my premium payments?

Your life insurance premiums will depend on your age, health history, gender, occupation, lifestyle habits, the life insurance plan you choose, and the coverage amount you wish to buy.

Life insurers have different underwriting guidelines, which means they all assess risk differently.

Insurance companies also offer the option of level premiums, where the insured will maintain an established premium payment for a certain amount of time, without the risk of price fluctuations.

To get the lowest possible premium, shop around and get quotes from different life insurance companies.

Is universal life insurance a good investment?

Like any financial adventure, your policy’s investment account has its risks. Your policy’s cash value growth will depend on the securities your policy invests in, interest rates, and the stock market’s performance.

You should consult with a financial advisor before purchasing a policy.

Do I need my life insurance policy to grow cash value?

Not necessarily. Cash-value life insurance is best for shoppers who can afford higher premium payments and have exhausted other investment options, such as IRA, Roth IRA, and 401(k) accounts.

Suppose your financial situation is uncomplicated, and you need life insurance only for a specific time. In that case, a term life insurance policy can be the most suitable and affordable option with high coverage amounts.

What is variable universal life insurance?

A variable universal life policy is a type of permanent life insurance that provides options for investing your cash value. You can invest in bonds, money market accounts, an index, or a portfolio.

Summary of Money’s Guide to Universal Life Insurance

Universal life insurance may be right for you if:

  • You want coverage that lasts a lifetime
  • You are willing to manage and monitor your policy’s investment account
  • You understand the risks involved