Universal Life Insurance Explained: A Comprehensive Guide
Universal life insurance (UL) is a type of permanent life insurance that provides lifetime protection while building cash value with tax advantages. It offers flexibility in premium payments, making it a potentially cost-effective option compared to whole life insurance. However, this flexibility comes with fewer guarantees, requiring careful management to ensure the policy remains in force and the death benefit is maintained. This article provides a detailed overview of universal life insurance, its features, benefits, drawbacks, and how it compares to other life insurance options.
What is Universal Life Insurance?
Universal life insurance is one of the two main types of permanent life insurance, the other being whole life insurance. Like whole life, a universal policy can provide lifetime protection while building cash value with tax advantages. Universal life insurance is also called adjustable life insurance. Policies typically last until a certain age, such as 95 or 120. This coverage offers flexibility that other permanent policies - like whole life insurance - don’t. For example, you can adjust the amount you pay in premiums, which may appeal to people like freelancers or business owners whose income can vary. Universal life insurance is a type of permanent life insurance plan that typically has an investment function and flexible premiums.
Why Choose Universal Life Insurance?
People choose universal life insurance for several reasons:
- Lifetime Protection: From the first day the policy is in effect, UL can provide an income tax-free death benefit to help protect your family’s financial wellbeing. As long as you keep a positive cash value amount, your coverage can’t be cancelled.
- Cash Value: Like all permanent life insurance, it has a built-in cash value that grows over time and earns interest. The policy’s cash value grows on a tax-deferred basis, so no taxes are owed on current earnings or interest.
- Flexible Premiums: UL lets you raise or lower your payments within certain limits as your circumstances change. That flexibility can make it easier to keep your insurance policy in force if your earnings vary.
- Tax Advantages: The death benefit is paid income-tax-free to beneficiaries.
How Universal Life Insurance Works
Universal life policies work in a similar way to other permanent policies. In exchange for premiums, you typically get lifelong coverage and your beneficiaries receive a payout when you die. You also have the opportunity to build cash value and take out loans while you’re still alive.
There are two parts to every premium payment:
Read also: Is Indexed Universal Life Right for You?
- Cost of Insurance (COI): The cost-of-insurance component covers the cost of providing the death benefit and life insurance company administrative fees. It’s typically the minimum premium needed to keep the policy in effect, and the COI rises over time because it is based mainly on the policyholder’s age.
- Cash Value: The wealth-building component. Any premiums paid over the COI amount add to the policy’s cash value, subject to an upper limit set by the IRS.
When you make a premium payment, the insurance company takes out the cost of the insurance as well as any fees. The rest is added to your policy’s cash value, which can grow over time based on an interest rate set by the insurance company. Universal life policies come with a guaranteed minimum interest rate.
Note that minimum premium payments reduce the accumulation of cash value. As COI rises over time, it can result in cash value erosion, to the point that the insurer may require higher premiums in later years to prevent coverage lapse. That’s why many people choose to build the cash value by paying maximum premiums for the first several years - then using those funds if needed to help lower premium costs later on.
Universal Life Insurance Cash Value
The cash value of a universal life insurance policy can grow at a secured rate, whether pre-determined or based on a variety of investment options. You can also have more say in the method that the cash value will grow. How you adjust your premium payments can directly affect the value of your universal life insurance policy. Some of the greatest benefits of choosing a universal life insurance policy are that you have more input on how the cash value accumulates, premiums are adjustable, and they can yield a substantial death benefit. On the other hand, there are some disadvantages to universal life insurance too.
Universal Life Insurance Premiums
The main perk of universal life insurance is the ability to adjust your premiums. You can pay more than the minimum premium, up to a certain limit, and the additional funds - minus any fees - are funneled into your cash value. Alternatively, you can pay less than the minimum premium. If you do this, make sure you have enough cash value to cover the cost of insurance and other charges or else your coverage could lapse. We recommend you make these decisions carefully, balancing short-term and long-term goals evenly. Some people find peace knowing their premiums will not change over time. While you do have the flexibility to skip premium payments or scale the premiums down, it may not be the best long-term decision.
Universal Life Insurance Death Benefit
You usually have the option to decrease your life insurance death benefit, which can be handy if you no longer need as much coverage. Some insurers may allow you to increase your coverage, though this option is not as common.
Read also: Is Variable Universal Life Right for You?
In general, there are two types of death benefits to choose from:
- Level Death Benefit: In most cases, the death benefit amount remains the same through the life of the policy. For example, if you buy \$100,000 of coverage and build up \$60,000 of cash value, your beneficiaries receive \$100,000 when you die.
- Increasing Death Benefit: Your cash value balance is added to the death benefit. So, in the previous example, your beneficiaries would get \$160,000: the death benefit plus the cash value. This option comes with higher premiums.
Types of Universal Life Insurance
There are several types of universal life insurance policies available:
- Standard Universal Life Insurance: This is the most common type, offering flexible premiums and a cash value component that grows based on an interest rate set by the insurance company.
- Guaranteed Universal Life Insurance: Guaranteed universal life insurance doesn’t require the same hands-on approach as standard universal life insurance and is often described as a compromise between term and whole life. It offers lower rates because the cash value growth is minimal. It often offers a no-lapse guarantee. This means you'll keep your insurance as long as you pay the minimum premium required to cover the cost of insurance. As long as you pay the amount required to maintain the guarantee - which may be higher than the minimum premium - your death benefit will remain in place, even if your cash value drops.
- Indexed Universal Life Insurance (IUL): Indexed Universal Life Insurance (IUL) is a type of permanent life insurance policy that combines death benefit protection with a cash value component. The cash value of an IUL is tied to a stock market index, such as the S\&P 500, allowing the cash value to grow based on the performance of the index, subject to a certain floor and cap. If you’re interested in UL’s flexibility, indexed universal life insurance (IUL) is another option. You can adjust the death benefit and premiums within certain limits. Your cash value will be tied to a stock market index, like the S&P 500 or a combination of indexes. You also have a fixed-interest option. IUL policies have participation rates, caps and floors. However, your money isn’t invested in the market - the index just provides a reference for how much interest the insurance credits to your account.
- Variable Universal Life Insurance (VUL): Variable Universal Life Insurance gives you the same kind of lifetime protection and payment flexibility as standard universal life with more investment options: you can invest part or all of your cash value in “subaccounts”. Variable universal life insurance has a cash value portion that’s invested in various subaccounts of your choice. It has higher potential returns and losses, so it comes with greater risk. If flexibility is paramount, but you also want the ability to manage your own investments, variable universal life (VUL) is a worthy consideration. Your premium and death benefit can be adjusted, within certain limits, and your cash value is tied to sub-accounts you choose and manage. However, you have to choose and manage investments as you would in a brokerage account. And as with a brokerage account, you also assume more risk, including the possibility of losing part or all of your principal.
Pros and Cons of Universal Life Insurance
If you’re in the market for a permanent life insurance policy and the premiums fit your budget, universal life insurance offers a lot in the way of flexibility and potential returns. But it has downsides, too.
Advantages of Universal Life Insurance
- Flexible Premiums: Universal policies allow you to change the size and frequency of your payments, which can be handy when times are lean. However, paying less can put you at risk of a policy lapse. Universal life insurance generally gives you the ability to fully customize your protection up-front and make adjustments down the road.
- Flexible Death Benefit: Your policy may include the option to increase the death benefit if you need more, although you'll usually have to take a medical exam to qualify for extra coverage. If you want to decrease your death benefit, you can typically do so after the policy has been in force a few years.
- Potential Cash Value Growth: The money in your cash value account will earn interest at the rate set by your insurer, and that rate can change frequently. With Guardian, the minimum interest rate is guaranteed never to be lower than 2% annually - and it can go higher. The cash value of a universal life insurance policy can grow at a secured rate, whether pre-determined or based on a variety of investment options. Your insurer invests some of your premiums. It offers a guaranteed minimum interest rate.
- Access to Cash Value: You can usually access your universal life insurance policy’s cash value while still alive through policy loans, withdrawals, or surrendering the policy. With a policy loan, you can repay the funds over time on your own schedule. This type of loan may come with lower interest rates. If you take out a policy loan from your life insurance plan, the loan won't be taxable. The exception to this is if the policy terminates before you’ve repaid the loan. You can withdraw up to the amount of the total premiums you’ve paid into the policy without paying taxes.
- Customization: There are many ways to configure your universal life policy. You can design your coverage to last for as little as fifteen years, for your lifetime, or somewhere in between.
Disadvantages of Universal Life Insurance
- Requires You to Monitor Your Policy: If you don’t pay attention to the cash value, the policy may become underfunded. This could mean making large payments to maintain the coverage you signed up for. The flexibility and freedom of universal life also mean that there are fewer guarantees.
- More Exposure to Risk: When interest rates rise, your universal life insurance looks like a shrewd decision. But if rates drop, your cash value may not grow as you’d hoped. Fortunately, universal life insurance policies typically come with guaranteed minimum interest rates.
- Complexity: With more options than term or even whole life coverage, a UL policy can be complex. The policy needs to be managed: you need to determine how much you want to pay for premiums, and with variable UL, you also have to make investment choices. Those variables, along with a cost of insurance that increases over time, can affect and even detract from the value of your cash value. So you also have to keep an eye on your value balance over time: If it goes down to zero, your premiums could go up, or the policy may lapse.
Universal Life Insurance vs. Other Options
Universal Life vs. Whole Life Insurance
Similar to universal life, whole life policies are a type of permanent coverage, which means they can last your entire life. But, unlike universal life, whole life policies have fixed premiums and death benefits and offer consistent cash value growth.
Here’s a comparison table:
Read also: What is Indexed Universal Life?
| Feature | Universal Life Insurance | Whole Life Insurance |
|---|---|---|
| Coverage Period | Lifetime | Lifetime |
| Premiums | Can vary | Fixed |
| Cash Value | Yes, but not guaranteed | Yes, with guarantees |
| Dividends | No | Yes |
| Cost | More expensive than term; but often less than whole life | More expensive than term |
| Guarantees | Fewer guarantees | Guaranteed premiums, cash value growth, and death benefit |
| Flexibility | High flexibility in premium payments and death benefit | Less flexible |
| Management | Requires monitoring and management of premiums and cash value | Less management required |
If you want a permanent policy that you don’t need to monitor as closely, whole life may be the simpler option. If you want to adjust your coverage and premium payment over time, you may want to consider universal life.
Universal Life vs. Term Life Insurance
The only similarity between term and universal life insurance is that they include a death benefit. They differ in nearly every other way. Term life is for a specific period, with fixed premiums and a guaranteed death benefit if you die within the term. Term does not have a cash value component but offers cheaper premiums than other types of life insurance.
Here’s a comparison table:
| Feature | Universal Life Insurance | Term Life Insurance |
|---|---|---|
| Coverage Period | Lifetime | Limited to a specific term (typically 10-30 years) |
| Premiums | Can vary | Fixed |
| Cash Value | Yes, but not guaranteed | No |
| Dividends | No | No |
| Cost | More expensive than term | Less costly than whole life or universal life |
| Renewability | Renewable, but premiums may increase significantly with age | Not renewable without a new policy |
| Convertibility | May be convertible to permanent insurance | Typically not convertible |
If you’re simply looking for affordable life insurance coverage, term life insurance is sufficient for most people. It can be used to cover the time period when your death and lost income would have the greatest financial impact on your family.
Comparing Universal Life, Whole Life, and Term Life Insurance
| Feature | Term Life | Whole Life | Universal Life |
|---|---|---|---|
| Coverage Length | Temporary - typically 10, 20, or 30 years | Lifetime | Lifetime |
| Builds Cash Value | No | Yes | Yes |
| Death Benefit | Fixed | Fixed | Flexible |
| Premiums | Fixed | Fixed | Flexible |
Cost of Universal Life Insurance
Universal life is typically more expensive than term life insurance. Universal life generally offers the most life insurance benefit for your dollar.
Here are the average annual premiums for a \$500,000 universal life policy compared with whole life, as of February 25, 2025:
Universal Life vs. Whole Life Insurance Rates for Men
| Issue Age | Universal Life | Whole Life |
|---|---|---|
| 30 | \$2,174.33 | \$4,311.33 |
| 40 | \$3,101.33 | \$6,387 |
| 50 | \$5,048.67 | \$10,068.67 |
| 60 | \$8,556.67 | \$16,697.67 |
Source: Covr Financial Technologies. Lowest three rates for each age averaged
Universal Life vs. Whole Life Insurance Rates for Women
| Issue Age | Universal Life | Whole Life |
|---|---|---|
| 30 | \$1,857.33 | \$3,958.67 |
| 40 | \$2,698.33 | \$5,859.67 |
| 50 | \$4,563 | \$9,037.33 |
| 60 | \$7,544.33 | \$12,829.33 |
Source: Covr Financial Technologies. Lowest three rates for each age averaged
Universal Life Policy Riders
There are several riders your insurance company may offer for a universal life policy. Life insurance riders are add-ons you can use to personalize your policy. They might add coverage features or guarantees, but they’re typically optional or come with an additional cost.
Common riders include:
- No-Lapse Guarantee Rider: As long as you pay the amount required to maintain the guarantee - which may be higher than the minimum premium - your death benefit will remain in place, even if your cash value drops.
- Waiver of Premium Rider: This pauses premiums if you become disabled. The rider keeps your policy in force, but no funds are added to the cash value.
- Accelerated Death Benefit Rider: This allows you to access some or all of your death benefit while you’re still alive if you’re diagnosed with a terminal, critical or chronic illness. The terms of the rider vary by insurer, so check to see what’s covered by your insurer’s accelerated death benefit and how much it pays out.
- Child Term Riders and Spouse Riders: These riders allow you to add coverage for other members of your family under your universal life policy.
- Accidental Death Benefit Rider: An accidental death benefit rider increases the payout from your policy if you die in, or as a result of, an accident.
- Guaranteed Insurability Rider: This allows you to increase your policy’s death benefit at specific life stages or policy anniversaries, without an exam or health questionnaire. For example, with a guaranteed insurability rider you could increase your death benefit when your child is born, even if you’ve developed a medical condition.
How to Find the Best Universal Life Insurance Company
Universal life policies are complex, so to find the right company, focus on these three things:
- Financial Strength: You'll want a life insurance provider that’s financially strong so you'll know your cash value is safe and your beneficiaries will receive a payout when you die.
- Policy Types: You should find a company that offers the policy options and riders you’re looking for. Premiums and fees for universal life policies can vary between companies, too.
- Expert Advice: Finally, it’s a good idea to consult a fee-only life insurance consultant.
Is Universal Life Insurance Right for You?
Universal life insurance can be a powerful financial tool that can help protect your family’s financial wellbeing for decades to come. It can give you the flexibility to help build assets, deal with life’s uncertainties, and even pass on wealth to the next generation. It may be a good choice if you are looking for permanent coverage, greater adjustability, and more awareness of how your cash value grows. If you want life insurance that has adjustable premiums, universal life insurance may be right for you.
Ask yourself what you want the life insurance policy to achieve. Weigh the pros and cons of a universal life policy to decide whether this type of insurance is right for you. Consider the following checklist:
Checklist: Is universal life insurance right for me?
| What I want: | What I should get: |
|---|---|
| I want life-long protection | Whole or universal life |
| I want to build tax-efficient cash value | Whole or universal life |
| I want access to policy cash while I’m alive | Whole or universal life |
| I want the flexibility to raise or lower my premiums | Universal life insurance |
| I want cost-efficient permanent coverage | Universal Life insurance |
| I want guaranteed cash value growth | Whole life insurance |
| I want a guaranteed death benefit | Whole or term life |
| I want guaranteed level premiums | Whole or term life |
| I want the biggest death benefit per premium dollar | Term life insurance |
Alternatives to Universal Life Insurance
One common alternative to ULI is the strategy of buying term life insurance and investing the premium savings in other financial instruments, such as stocks, mutual funds, or retirement accounts.
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