Universal life, which is permanent insurance that lasts the insured's life, has a low premium and an investment saving element similar to term life insurance. Flexible-premium options are a common feature in UL policies. Some policies require a single premium or fixed prices.

How Does Universal Life Insurance Work?

Universal life insurance offers policyholders the security of a death benefit and the potential to build financial worth throughout their coverage. Generally speaking, universal life insurance plans are comprised of two different parts. An investment account that accumulates cash value depends on how well the market does over time, in addition to a basic death benefit coverage that is guaranteed to stay the same during the duration of the policy.

The cash value component operates similarly to the cash value component of other permanent plans, such as whole life or index UL. This account is used to keep monies that the insurance company has invested for the benefit of the covered party. This account accumulates interest depending not only on the performance of the market but also on the policy's provisions.

Universal policies have more flexibility regarding premiums and death benefits than permanent insurance. This is a key difference between UL and other types. The insurance company may limit the options for policyholders to adjust their premiums or reduce their death benefit coverage. Universal life insurance is a great choice for people who need permanent insurance coverage but cannot pay high premiums.

Universal life insurance policies offer flexibility in accessing cash value. Policyholders can borrow from their cash value account or take out loans without having to trigger a tax event. Individuals who want to increase their cash value and have the ability to access funds as needed can find UL a useful financial planning tool.

Advantages and Disadvantages

The cash value of a UL policy earns interest based either on the current market rate or the minimum interest rate. Policyholders can access cash value as it accumulates without affecting the guaranteed death benefit. Withdrawals will, however, be subject to tax.

Earnings may be provided as first in, last out (LIFO) or first in, first out (FIFO), depending on the date the insurance was purchased and the premium payments. Upon the insured's passing, the insurance company will keep any residual cash value, while the beneficiaries will only get the Death Benefit specified in the policy.

Universal life policyholders can borrow against the accumulated value of their policy without any tax consequences. If they do, however, interest will be charged on the loan amount and a cash surrender fee. Any outstanding loans will reduce the death benefit. Unpaid interest on the loan will also be deducted from the remaining cash value.

UL insurance policies can offer flexible premiums, unlike whole-life insurance policies with fixed premiums for the entire policy's life. Policyholders have the option to make payments that exceed the COI. The excess premium increases the cash value, and interest is accrued. Policyholders who have enough cash value may be able to skip payments and not risk a policy lapse. Policyholders should be aware of the increased insurance cost as they age. The credited interest may mean there is not enough cash value to keep the policy valid, leading to higher premiums.

Universal Life Insurance vs. Whole Life insurance vs. Term Life Insurance

Universal life is a type of permanent insurance that allows policyholders flexibility in paying premiums and cash savings. It also provides a death benefit. As the policyholder ages, premium costs can change with interest rates.

Universal life insurance lets you borrow against it or cash in its savings section. This grows tax-deferred throughout your life. Term life is coverage provided by an employer for specific years. Usually, it lasts 20-30 years. Once the term expires, it ceases. Term life is affordable and has low premiums. However, there is no cash component that you can borrow from or cash in. The death benefit is null and unenforceable if the term ends.

Whole life insurance can also be considered a permanent type of insurance. It has a cash value savings component. Universal life insurance offers more flexibility than whole life insurance regarding where you can put your policy's cash values. Universal premiums can be redeemed for as long as the policy is in force, while premiums for whole life insurance are not.