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What Is Universal Life Insurance?


Universal life insurance, like whole life insurance, is a form of permanent life insurance that builds up cash value tax-deferred. The coverage will continue to cover you as long as you live and pay the payments. A term life insurance policy, on the other hand, is only valid for the length of the policy and does not accrue cash value.

The most significant distinction between whole and universal life – sometimes known as adjustable life – is that universal life is more adaptable. Some universal life plans, for example, let you can adjust your premium payment schedule or raise the death benefit. Universal life, on the other hand, is more expensive and difficult than term or whole life. As a result, it isn’t suitable for everybody. Is it a viable choice for you? Continue reading to find out.

What Is Universal Life Insurance?

Universal life insurance, according to the Insurance Information Institute, gives perpetual coverage and alternatives that whole life insurance does not. A universal life insurance policy, for example, may allow you to enhance the death benefit without having to purchase a new policy.

The death benefit is the amount that will be paid to your beneficiaries if you die. You might be able to reduce your premium payments as well. If one or both of these alternatives are available, it will be determined by the amount of money in the policy, also known as the cash value.

Differences between Term, Whole, and Universal Life Insurance

Cash value accumulates if premium payments and interest on those payments surpass the cost of insurance, according to the California Department of Insurance and the Washington State Insurance Commissioner (COI). Similarly, if the COI is greater than your premium payments plus interest, the policy’s cash value declines. The COI establishes the minimum premium payment required to keep the insurance in force.

The COI covers a portion of the insurance company’s operational expenditures, such as agent wages, legal fees, and leasing fees, according to the New York State Department of Financial Services. The COI is also influenced by your mortality, or the risk of dying while the policy is in effect, as well as the amount of coverage you have. As you become older, your COI rises, leading in larger premium payments – something to consider if you’re retired and living on a limited income.

The interest rate on a universal life insurance policy’s cash value component is linked to the insurance company’s portfolio or a market index. These profits raise the account’s cash value, allowing you to boost your death benefit or reduce the amount or frequency of your premium payments if the account has enough money in it to cover the difference. If your beneficiaries’ financial requirements change, increasing your death benefit may be a sensible alternative. If you’re in a tight financial spot, lowering your premium payments or increasing the frequency of your payments can assist.

If you choose one of these alternatives, your policy’s cash value will begin to deplete. The insurance may lapse if you use up all of the cash value, leaving you without coverage. To avoid this, reduce your death benefit and/or increase your premiums before the policy expires.

It’s a good idea to speak with your insurance agent first, especially if you’re thinking about cutting your monthly payments for a long time. He or she will assess if you have accumulated sufficient monetary value and will be able to explain all of the implications.

It’s hard to anticipate how much a universal life policy’s cash value will increase or decline over time because it’s based in part on a market interest rate. Consider a whole life insurance if you’re not comfortable with this level of financial risk but still want a policy that builds cash value. Its cash value increases depending on an annual fixed interest rate established by your insurance carrier.

How Does Universal Life Insurance Work?

Universal life is a sort of permanent life insurance with cheaper premiums than whole life, which is another type of permanent life insurance. Most universal life plans let you to customize your death benefits and premium payments, and they accumulate cash value over time. Some policies feature a set premium or require a single premium payment up ahead.

A life insurance policy’s cash value functions similarly to a savings account, generating market interest. You can access some of your cash worth without affecting your death benefit if you’ve accumulated enough. You can also utilize the surplus cash value to avoid paying one or more premium payments.

Although the cash value of the policy increases tax-deferred, any money you take will be taxed. Furthermore, when you die, your beneficiaries will not receive any of the cash value; they will only receive the death benefit, and the insurance company will keep any surplus money in the policy. You keep some or all of the cash value accumulated if you cancel the insurance during your lifetime.

A universal life policy’s cash value can also be used to borrow against. If you pay it back while the insurance is still active, the loan isn’t taxable, and it doesn’t need an application or a credit check. However, insurance firms sometimes impose significant administrative costs, and the death benefit is typically lowered by the amount of any unpaid debts, as well as the policy’s cash value. Furthermore, if the loan and interest are not paid, the insurance may lapse.

Moreover, the policy might lapse if the loan and interest together exceed the cash value.

Although cash-value life insurance products such as universal life have some benefits, they also have significant drawbacks. Cash-value plans, according to David Paige, an insurance industry attorney and consultant based in New York City, are “a forced-savings mechanism” that may not be suitable for everyone. He points out, for example, that commissions paid to agents or brokers who sell cash-value plans might be more than 100% of the total premiums during the first year, implying that the policyholder would not acquire any cash value during that time.

Furthermore, according to Paige, investment funds set up by insurance firms to invest premium payments are “pretty cautious” and don’t expand very quickly. “Plus, many of these funds have fees upon fees that aren’t often revealed unless you’re really excellent at reading the fine print.”

Some insurance regulators, according to Paige, have disfavored plans that let individuals to choose investment vehicles – notably, but not primarily, variable universal life policies (see below). “Many people who buy these products aren’t financially literate, and growth estimates might be too optimistic and based on assumptions that aren’t always accurate,” he adds. “It’s not so much an issue with the policies as it is with how they are presented.” Paige adds that this is not true of all universal life policies, and that many of them are completely acceptable. However, if you’re thinking about getting a universal life insurance policy, be aware of the potential drawbacks.

Universal life insurance has a maturity date, despite the fact that it is deemed “permanent.” The maturity date is when you reach a stipulated age under the policy, which is generally 85 or higher. You’ll be paid and your coverage will stop after this date.

Although the payout is often equal to the policy’s cash value, it might be be the death benefit or another sum. When purchasing a policy, choose a maturity date carefully to ensure that coverage lasts long enough to meet your financial objectives.

Beneficiaries often get death benefits in the form of a single tax-free payment. They may be able to receive monthly or yearly installments instead in some situations. An annuity, which shares the benefit between monthly installment payments and an investment account, might also be a viable alternative. Beneficiaries may have to pay taxes on interest earned if the benefit earns it.

Universal life insurance is divided into two types: variable universal life and indexed universal life. A variable universal life policy offers the same benefits as a conventional universal life policy, with the distinction that you pick how the cash value is invested rather than the insurance company. Stocks, bonds, mutual funds, and other vehicles are examples of investment alternatives.

You have the option of investing the funds in one or more accounts. Variable universal life insurance is difficult to understand, can have hefty management fees, and entails a high level of investment risk. As a result, it is unlikely to be the best option for the majority of individuals. Variable universal life, on the other hand, may be worth considering if you’re willing to take on the risk and want a possibly better rate of return than normal universal life.

Indexed universal life is a type of universal life policy in which the interest rate is determined by the performance of one or more index funds chosen by you. The S&P 500, NASDAQ 100, and other notable indices are examples. You could also be able to put a portion of the cash value into a fixed-rate account and the rest into an index fund.

The amount in the fixed-rate account will have a higher guaranteed interest rate and be less risky, but it will also have a lower potential rate of return. It’s worth noting that the index-linked component of the cash value isn’t really invested in the index. Instead, the amount of interest you get is linked to the performance of that index, and the insurance company normally caps the rate of return on that money at around 10% to 12%.

You might also want to look into universal life insurance with no exam. This sort of insurance does not need a physical examination during the application procedure, as the name indicates. It is normally significantly more expensive than conventional life insurance, and it is not always available to smokers or persons with pre-existing medical issues.

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