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