What Is Universal Life Insurance?

A variation of whole life insurance, universal life policies offer permanent life insurance protection. Like whole life policies, universal life insurance builds cash value over time on a tax-deferred basis. Unlike whole life, universal life gives policyholders the ability to adjust their death benefit and premiums as their needs change over time. This flexibility is what most distinguishes universal life insurance from whole life coverage. In this post, we’ll explain more about what universal life insurance is and what its pros and cons are.

Basics of Universal Life

Also known as flexible premium adjustable life insurance, universal life came about in the early eighties as an alternative to whole life coverage. With whole life, a portion of the policyholder’s premiums are invested by the life insurer in funds, bonds, and mortgages. The return earned on these investments is then applied to the policy on a tax-deferred basis. Typically, universal life policies have a minimum guaranteed interest rate that gives policyholders a certain amount of money regardless of how the insurer’s investments perform. These cash value credits allow the policyholder to decide, within reason, how much of a premium he/she would like to pay each month. If the premiums are not large enough to cover the costs of the policy, the difference is withdrawn from the cash value.

Death Benefit Options

Universal life also allows the policyholder to change his/her death benefit, within certain limits, throughout the course of the policy. Typically, universal life insurance offers two death benefit options. The first option uses the policy’s cash value to pay the death benefit. In the second option, the insurer pays the death benefit according to the face value of the policy in addition to any cash value the policy accumulated over time. The latter option tends to have higher premiums associated with it.

Pros and Cons of Universal Life

On the plus side, universal life insurance offers policyholders unparalleled flexibility. Policyholders can change their death benefit as their coverage needs evolve, and they can adjust their premiums to accommodate income fluctuations. In this way, universal life is ideal for families who have inconsistent incomes. On the down side, if a universal life insurance policyholder pays minimal premiums for too long, the policy may lapse. In other words, the policyholder would be without life insurance protection if this happened. Additionally, if the investments of the issuing life insurance company perform badly, the cash value of the policy will not accrue as quickly as it should, thus forcing the policyholder to pay higher premiums.