Universal Life Insurance: Pros and Cons

Should you buy universal life insurance?

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A universal life policy is a flexible form of cash value life insurance. With it, you can change premium payments and invest more (or less) into your cash value for potential growth. 

But there are pros and cons to these features. We’ll explore some of the most important aspects of universal life insurance below.

Key Takeaways

  • Universal life insurance allows for flexible premiums, but you need to maintain a cash value that’s sufficient to support the policy.
  • The cash value is available for withdrawals and loans, but tapping the cash value could result in a loss of coverage or taxes.
  • Any outstanding policy loans upon your death will reduce the amount your beneficiaries receive.
  • The cash value might grow with good performance, but if it doesn’t, you may need to pay extra into your policy.
  • Universal life insurance is also available as variable universal life and equity-indexed universal life.

What Is Universal Life Insurance?

Universal life is a form of cash value insurance that lets you adjust premium payments and the death benefit, and some policies have investment options. Like all life insurance policies, this form of insurance pays a death benefit to beneficiaries when an insured person dies. But it’s different from whole life and term insurance.

Universal Life Term Life Whole Life
Flexible premiums and death benefit Fixed premiums and death benefit Fixed premiums and death benefit
Potential lifelong coverage Temporary coverage Potential lifelong coverage
Multiple investment options with different types of UL policies No cash value or investment component Fixed growth rate
Premiums, death benefit, and cash values are NOT guaranteed Premiums and death benefit guaranteed for coverage term Premiums, death benefit, and cash values guaranteed

Pros and Cons of Universal Life Insurance

Potential Advantages
  • Flexible premiums and death benefit

  • Cash value

  • Investment options

Potential Pitfalls
  • May fall short of expectations

  • Potentially high premiums

  • Potentially high fees

Pros Explained

Flexible Premiums and Death Benefit

Universal life insurance typically does not have a rigid premium schedule—which could be helpful if you have an irregular income. For example, you can skip payments, decrease the amount of your payment, or pay in “chunks'' when you have money available. This is different from term life and whole life insurance, which may require you to pay regular premiums to maintain coverage. Still, you need to keep enough cash value in the policy to pay expenses—otherwise, you could lose coverage and face tax consequences.

You can also choose between different death benefits with a universal life policy: increasing or level. With the increasing option, your beneficiaries receive the face amount of the policy plus the cash value. With the level option, they receive the face amount only. The former is more expensive.

Cash Value

Universal life insurance has a cash value that can potentially grow over time. If you build up a substantial amount, those funds might pay for internal costs and keep your policy in force for your entire life. What’s more, you might be able to borrow from the cash value or withdraw funds from your policy. Also, if you decide you no longer need coverage, you could potentially recapture more than what you paid into the policy.

However, a surrender charge often applies to withdrawals from permanent life insurance within the early years of the contract, and withdrawals in excess of the premiums you paid in are typically taxable.

The ability to skip premiums or access your cash value comes with risks. If your policy runs out of money, you may lose coverage, and you could owe taxes if you withdraw more than you pay into the policy. If you have outstanding loans upon your death, they’ll reduce the amount your beneficiaries receive.

Investment Options

If you’re willing to take risks, you might appreciate exposure to investments inside of a universal life insurance policy—this is an option with variable universal life insurance. These policies allow you to invest the cash value in market investments, similar to mutual funds.

If the investments perform well, the cash value can grow and reduce the amount you need to pay in—or lead to a bigger death benefit. But you can also lose money in the market or experience less growth than expected. If that happens, you may need to pay substantially more into the policy to afford ongoing policy expenses and keep your coverage in force.

Indexed universal life (IUL) insurance is a type of coverage that can participate in stock market gains without direct market exposure. The cash value is credited a rate of return based on how a benchmark index, such as the S&P 500, performs. But these policies are complicated, and gains are limited by design. Even though you can’t lose money in the market, the cash value can diminish if gains aren’t sufficient to offset policy expenses.

In “regular” universal life policies, the cash value is not invested in the market, nor is it credited a rate of return based on a stock market index. Instead, cash value gains are generally based on current interest rates.

Cons Explained

May Fall Short of Expectations

When evaluating a policy, you typically assume that you’ll earn a certain amount on your cash value over time. If earnings fall short of those assumptions:

  • You may not be able to withdraw or borrow from the cash value and maintain lifelong coverage.
  • You may need to pay more into the policy than you originally expected.
  • You may need to pay premiums for a longer period of time than initially anticipated.

Put simply, if the cash value doesn’t grow as expected, you won’t have as much flexibility with the policy—and you could potentially lose coverage if you aren’t able to increase premium payments.

Potentially High Premiums

If you only need life insurance for a limited time, you might pay lower premiums with term insurance. For example, if you have a young family and just want to protect your children and spouse while your children are growing up, you might not need permanent insurance. With universal life, you pay relatively high premiums designed to build up a cash value that supports the policy for your entire life. But with a term policy, you can pay a much lower cost for life insurance or even afford more coverage.

It’s important to work with reputable insurance agents when shopping for universal life insurance. If agents use unrealistic assumptions, the premiums will appear low. And if you don’t experience sufficient growth, you’ll need to pay substantially more in later years.

Potentially High Fees

Some universal life insurance policies have high internal costs. Those fees can erode the cash value and make it harder to keep a policy in force. Fees can be particularly high with variable universal life insurance, but it’s important to review any policy you’re considering carefully.

Alternatives to Universal Life Insurance

Choosing the right type of life insurance can save you money and ensure adequate protection for your loved ones. It’s best to explore the pros and cons of each option with an insurance agent and a financial planner.

Term Life Insurance

Term life insurance is temporary coverage and relatively inexpensive. You choose a death benefit and a length of time for coverage, such as 20 or 30 years. While term life insurance doesn’t have a cash value, you can invest the money you save on premiums (relative to purchasing permanent insurance). Doing so might provide a source of funds that’s similar to the cash value in a universal life policy.

Another advantage of term life insurance is that it’s easier to afford higher coverage amounts, which may be valuable if you only need coverage for a limited period of time.

Whole Life Insurance

Whole life is another type of permanent insurance, and it’s similar to universal life. A whole life policy includes a cash value. However, with whole life, the death benefit and cash values are determined ahead of time and scheduled in the policy. Timely payment of a level premium (determined at the policy's issue) generally guarantees your policy stays in force. If you don't pay premiums consistently, you risk losing coverage. You also don’t have the same flexibility that’s available with universal life—such as flexible premium payments and an increasing death benefit option.

Is Universal Life Insurance Right for You?

If you need life insurance coverage and you prefer to have a policy that’s customizable and flexible, universal life insurance could make sense. These policies allow for irregular premium payments, and some policies let you invest the cash value in the stock market in hopes of long-term growth. If all goes well, a universal life insurance policy can provide coverage that lasts for your entire life and a pool of funds to draw from, if needed.

But bear in mind that policy values—like the death benefit, cash value, and premiums due—are not guaranteed. If cash value returns are less than anticipated and you don’t increase premium payments, the policy could lose value or even lapse. If you prefer guarantees over flexibility, whole life insurance may be a better choice for permanent coverage.

Frequently Asked Questions (FAQs)

What is indexed universal life insurance?

Indexed universal life (IUL) insurance is a form of universal life. The cash value is linked to a market index, but IUL policies typically do not lose value in market crashes. If the index gains value, the cash value can potentially grow with the markets, but policy features limit your gains and upside potential.

How much does universal life insurance cost?

A life insurance policy’s price depends on factors like your age and health. Universal life insurance typically does not have a scheduled premium, so you might be able to skip premiums on occasion. However, you need to keep enough cash value in the policy to pay for the internal costs. Speak with an insurance agent to get a customized illustration. Remember that the assumptions might not pan out.

When is the interest paid in a universal life insurance policy?

The interest crediting frequency depends on your insurer’s rules and the type of policy you own. For example, some policies might credit interest daily. But with some indexed products, earnings (if any) are credited annually.

Article Sources

  1. Texas Department of Insurance. "Life Insurance Guide."

  2. Alabama Department of Insurance. “Types Of Policies.”

  3. New York State Department of Financial Services. “Types of Policies.”

  4. U.S. Securities and Exchange Commission. “Investor Bulletin: Variable Life Insurance.”