In 1979 the E.F. Hutton life insurance company introduced universal life insurance, also known as adjustable life. It was the first new type of life insurance product in over 100 years and featured flexible premiums that consumers could customize to their individual needs.
Today, universal life represents 34% of new life insurance policies sold.
What Is Universal Life Insurance?
Universal life (UL) is a form of "permanent" life insurance, and is designed to provide protection for long periods of time, typically for the entire life of the person named as the “insured” in the policy. Permanent life insurance also has a cash value, or savings component, from which money can be accessed by the owner of the policy.
Often the policy owner (policyholder) and the insured are the same person. But they don’t have to be. For example, someone could own and pay premiums on a policy in which their partner is the insured.
UL is different from other types of permanent life insurance because it doesn't have a set premium. You, the policyholder, can pay whatever you want within the minimum and maximum premium stated in the policy provisions. Minimum and maximum premiums are based on age, sex, medical history, and the amount of coverage. But of course, there can be a trade-off when you just pay the minimum, which we’ll get to in a minute.
How Universal Life Insurance Works
All permanent life insurance policies have three puzzle pieces that must fit together:
- Premium: The money you pay into the policy first goes to cover the company’s cost of insurance protection and administrative expenses. If you pay above the minimum premium, that excess goes to the savings component, or cash value. If you don’t pay a premium, policy charges are deducted from the cash value.
- Cash value: The cash, or account, value is a savings or investment component that is available to the policyholder. The cash value is credited with either interest earned by the insurance company's investment portfolio, or gains from an investment portfolio that the policyholder selects (in the case of a variable universal life policy). Cash value interest and gains are not taxed unless they are withdrawn or surrendered.
- Death benefit: Proceeds payable to beneficiaries at the insured's death are referred to as the death benefit or face value. Universal life has two basic death benefit options. Option A is a level death benefit, called the specified or face amount. Option B is the face amount plus the cash value. In Option A, more of your premium payment will go toward building the cash value; in Option B, more premium will go toward increasing the death benefit. Many companies offer additional death benefit options in the form of riders.
Death benefits received as a lump sum are typically income-tax-free to the beneficiary.
Universal life policies have two different “schedules” that are used to calculate the cost of insurance and other policy charges. These charges are what your premiums pay for, or, if you’re not paying premiums, they are deducted from the cash value. You can find them on your quarterly insurance statement.
The “current schedule” is based on the actual cost of the insurance company’s claims, investment results, and expenses. The “guaranteed schedule” indicates the maximum amounts you can be charged. The insurance company can raise or lower the current schedule, but not more than the guaranteed maximum stated in the policy.
With a UL policy, you can adjust premium payments up or down—a higher premium payment will increase the cash value, while a lower premium or no payment may decrease it, depending on how much interest is being credited to the cash value account. This flexibility is convenient if you need to lower premiums based on financial circumstances, or if you want to increase premiums to capitalize on the tax-deferred growth in the cash value. Other types of permanent insurance, like whole life, have a fixed premium schedule that can't be changed.
Though you can reduce or pause premium payments, it’s important to monitor the policy—if you don’t pay sufficient premiums, policy charges can eat away at the cash value until there’s little or nothing left, potentially causing your policy to lapse.
Surrender Period and Charges
Most universal life policies charge a penalty for canceling the policy or withdrawing more than a certain percentage of the cash value within an established period of time. Surrender periods are at the discretion of the insurer and can range, typically, up to 15 years. The surrender charges and how they are calculated are disclosed in the policy.
Types of Universal Life Insurance
UL policies are available in 3 styles.
The insurance company invests the cash value component as part of its general portfolio and interest is credited to the account based on the performance of the portfolio. Though fixed-rate universal life policies have a minimum interest guarantee, in a low-interest rate environment, they’re not attractive.
The vast majority of new universal life policies are indexed universal life policies (IUL)—70% of UL policies sold in the first quarter of 2020 were IUL. Indexed policies offer consumers the potential for stock market gains without the risk of losing principal.
The cash value component is credited based on the performance of a financial index, such as the S&P 500. If the index goes up, the cash value is credited with a percentage of the gain, usually up to a cap or ceiling stated in the policy. If the index goes down there are no interest credits, and no losses to the cash value.
The cash value component is invested in mutual funds the policy owner chooses. The cash value is determined by the gains and losses of the mutual funds selected. If investments perform poorly, the cash value can decrease, and the policy could potentially lapse if losses are great enough.
Pros and Cons of Universal Life Insurance
|Flexible premiums||Higher premiums than term insurance|
|Flexible savings component||Surrender penalties, often for 10 or more years|
|Coverage can stay in force for life||Expense charges and the cost of insurance can be increased (to the maximum in the policy provisions)|
|Favorable tax treatment|
Alternatives to Universal Life Insurance
There are two other forms of life insurance available on the market today.
Term insurance expires after a stated number of years, such as 10 or 30. Term insurance is pure insurance protection, meaning it has no cash value, and can be an inexpensive alternative, especially for young families who may need high amounts of protection for a limited number of years. For an additional premium, term insurance can be purchased with an option that allows for conversion to a permanent policy.
Whole Life Insurance
Whole life insurance, like universal, is permanent insurance and is intended to stay in force until the death of the insured. Whole life has a guaranteed fixed premium and cash values. It's also available with term insurance that supplements the insurance protection. Whole life is generally sold by mutual insurance companies that pay dividends to policyholders based on the company's profitability.
Adjustable life and universal life are used interchangeably to describe flexible premium life insurance policies.
Is Universal Life Insurance Right for You?
Anyone who has a need for a permanent life insurance policy should consider a universal life policy. Premiums can be adjusted (or paused) if necessary, and the cash value grows tax-deferred and can be accessed, in some cases, without tax consequences. Also, most universal life insurance products have a selection of living benefit riders to cover long term care expenses, supplement retirement income, and address other financial needs.
UL can also be a solid choice for young professionals who have or expect to have a need for insurance, want to lock in low rates while they’re young and in good health, and would benefit from the tax-deferred nature of the cash value account. In fact, if the cost of insuring you is low, you might find that the interest credited to your account covers the cost of insurance and policy charges.
In a low-interest rate environment, this example might be more likely with an indexed policy where interest credited is based on the returns of a stock market benchmark like the S&P 500.
- Universal life can be an affordable way to own permanent life insurance coverage.
- Universal life can be used for financial emergencies, long term care needs, and other living benefits.
- LIfe insurance death benefits are income-tax-free to beneficiaries.
- The most popular style of universal life is indexed.