Universal Life Insurance: Weighing the Advantages and Disadvantages

Universal life insurance and variable universal life insurance offer financial security for your loved ones. As long as you pay the premiums, your coverage can last the rest of your life. Plus, you can accumulate cash value that you can access during your lifetime. You have flexible premiums with these two types of universal insurance, letting you fund your life insurance more or less generously as your life circumstances shift. But as you weigh universal vs. variable universal life insurance, you'll notice a key difference around how your cash value accumulates-which can lead to certain advantages and disadvantages.

Understanding Universal Life Insurance

Universal life insurance is a type of permanent life insurance that offers lengthy coverage and builds cash value over time. 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.

How Universal Life Insurance Works

With universal life insurance, you build accumulated value, or cash value, by making premium payments and earning interest at a rate that can change but has a guaranteed minimum. A key feature of universal life is that you can adjust the size or frequency of your premiums-either to build cash value more quickly or slow down if your budget demands it.

Deductions are taken each month from your cash value to pay the costs associated with your contract, but as long as you have a sufficient balance, your universal life insurance will pay out a death benefit. You can also tap into your cash value while you're alive, although any amounts not repaid will lower the death benefit.

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.

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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.

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.

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.

Other Types of Universal Life Insurance

There are three other types of universal life policies you may want to consider.

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.
Indexed universal life insurance works similarly to a standard universal life policy, but the cash value is based on the performance of stock indexes like the S\&P 500 and Nasdaq composite. In some cases, cash value will be placed in a fixed account unless you choose other investments.
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.

Advantages 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.

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, so check with a fee-based life insurance advisor before making changes to your premium payments.
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.
Tax-Deferred Growth: The cash value in a UL policy grows tax-deferred, meaning you don't pay taxes on the growth until you withdraw the money.
Financial Flexibility: The accumulated cash value can be used in several ways. You can borrow, withdraw, or use it to pay premiums.
Estate Planning Benefits: UL policies are often used in estate planning to transfer wealth to beneficiaries tax-efficiently.
Access to Funds: You can take out loans against the policy's cash value without affecting the policy's death benefit if the loan is repaid.

Disadvantages of Universal Life Insurance

But it has downsides, too. Weigh the pros and cons of a universal life policy to decide whether this type of insurance is right for you.

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.
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: UL policies are more complex than other types of life insurance, such as term life insurance. They involve managing premiums, death benefits, and cash value growth, which can be confusing.
Potential for Increased Costs: Although UL policies offer flexible premiums, if the cash value does not grow as expected due to lower interest rates or poor market performance, you may need to pay higher premiums to keep the policy in force.
Variable Potential Cash Value Accumulation: The cash value is tied to market performance for types like variable universal life (VUL) or indexed universal life (IUL).
Potential Costs: UL policies often come with various fees and charges, including administrative fees, mortality and expense charges, and surrender charges.
Interest Rate Sensitivity: The interest credited to the cash value of a UL policy is often tied to market rates.
Risk of Losing Coverage: If the cash value is depleted due to insufficient premium payments or market downturns, and you do not pay the required premiums to keep the policy active, the policy could lapse.
Costly Early Termination: If you decide to cancel or surrender your policy early, you may face surrender charges.

Universal Life Insurance 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. So, 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. And 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.

Variable Universal Life Insurance: A Closer Look

Variable universal life insurance operates just like regular universal life except that instead of earning a minimum interest rate on your cash value, you invest it in market subaccounts, such as mutual or index funds. If the market performs well, your cash value may grow; if the market does poorly, your life insurance may lose value. You control the investment allocation by selecting from the subaccounts offered by your insurance provider.

How Variable Universal Differs from Universal Life Insurance

You'll find some distinctions variable universal and universal life insurance including investment options, risk, fees and complexity.

Variable universal lets you choose your investments
With universal life insurance, your cash value grows based on current interest rates, and some companies guarantee a minimum rate of return. You don't choose what to invest in, so this arrangement provides you with dependability but less control.
Variable universal life insurance involves investment subaccounts, and you decide how to invest your money within them. stocks. You have the control to potentially gain higher rates of return, but you also take on the possibility of losing money.
Variable universal poses a risk of losing principal
With universal life, your cash value won't decrease due to fluctuations in the market, but it may be reduced by monthly deductions needed to cover the cost of the insurance. Additionally, withdrawals and surrenders can lower your cash value and death benefit.
Variable universal life exposes you to the risk of market downturns when you select variable investments within your contract's subaccounts. If you sell investments at a loss, your cash value can decline. This could cause you to lose your principal. Significant investment losses could cause you to lose your cash value and decrease your death benefit.
Variable universal may have more fees as a tradeoff for market potential
Both universal and variable universal life have fees that pay for the coverage as well as the insurer's cost of doing business. But a variable universal life contract may have more charges for three main reasons:
- It provides an investment option. The more features within an insurance contract, the higher the premiums.
- The investments themselves come with expenses, just like investments outside of a life insurance contract.
- It needs a larger cash value cushion to help it withstand market downturns without lapsing.
It's important to realize, however, that this doesn't mean variable universal will necessarily "cost" more overall than universal life. As the adage goes, more risk can mean more rewards-and market access gives variable universal life the potential for greater earnings.
Variable universal tends to be more complicated
Variable universal life insurance is more complex than universal because of the investment component. You're in charge of how to invest your contract's cash value through investment subaccounts. While your financial advisor can help guide these investment decisions, they're ultimately up to you.

Who Should Consider Universal Life Insurance?

With its unique blend of flexibility and growth potential, universal life insurance can be a valuable tool for certain individuals and financial situations.

Individuals Seeking Flexibility: If you anticipate your financial needs and goals changing over time, the adaptability of universal life insurance can be a significant advantage.
People Looking to Build Cash Value: Universal life policies offer the potential to accumulate cash value on a tax-deferred basis. However, it's important to remember that universal life insurance might not be the ideal solution for everyone.
People Uncomfortable with Investment Risk: While certain types of universal life insurance offer potential cash value accumulation, they also come with greater risk.

Ultimately, the decision to purchase universal life insurance should be made after carefully considering your financial situation, goals, and risk tolerance.

How to Choose the Right Universal Life Insurance Policy

Choosing the right universal life insurance policy involves careful consideration of your financial goals, needs, and circumstances. Here are some steps to guide you through the process:

Determine Your Coverage Needs: Decide how much life insurance coverage you need. Identify Your Investment Goals: If you're interested in building cash value, consider how you want the investment component to work for you.
Premium Flexibility: Ensure the policy allows you to adjust your premium payments if your financial situation changes. Death Benefit Flexibility: Determine if you can increase or decrease the death benefit as your needs change.
For IUL and VUL Policies: Examine the investment options available to you.
Best, Moody's, or Standard & Poor's.
Policy Terms and Conditions: Carefully review the policy contract to understand all the terms, conditions, and exclusions.
Periodic Reviews: Life circumstances and financial goals change over time.

Following these steps, you can select a universal life insurance policy that aligns with your long-term financial goals while providing the flexibility and coverage you need.

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