Universal life insurance

Looking to build a tax-free inheritance to protect your family, but without the binding premiums? Universal life insurance could be the right choice for you.

Nupur Gambhir

Nupur Gambhir

Published November 14, 2019

KEY TAKEAWAYS

  • Universal life insurance is a permanent policy and has a cash value that can be used towards your premium payments

  • You can adjust your premium payments and death benefit at any point during the policy based on your financial situation

  • For most people, a term life insurance policy combined with a separate investment account will produce better earnings

Universal life insurance is a permanent life insurance policy with the added flexibility of using the policy’s cash value to pay for premiums. With universal life, the interest rate earned on the cash value is subject to change, whereas it is fixed with whole life insurance. Even though the policy is permanent, its offerings may be good for people who aren’t ready to commit to specific rates for the rest of their life.

In this article:

How does universal life insurance work?

Universal life insurance is a type of permanent life insurance that lasts your entire life, as long as you keep paying premiums while the policy is in force. When you die, it pays out a tax-free cash sum, called the death benefit, to your beneficiaries.

With universal life insurance, a portion of your monthly premiums goes toward a component called the cash value, which can earn a small amount of variable interest, and you can use the built-up cash value to pay for part of your monthly premiums. Once you die, the remaining cash value will go toward the death benefit.

However, just because there is a cash benefit to a universal life insurance policy doesn’t mean that it’s the best option to save money for the future. The variable interest rate often realizes a much smaller gain than you could get by investing the same amount in an IRA or 401(k). For example, the rate of return on universal life insurance is near 2%, while the rate of return on an IRA or 401k that matches historical stock market averages is 8%. Some of the best savings accounts can get over 2% interest, and the money would be available to you at any time.

The lower rates of return in a universal life insurance policy are why many financial advisors recommend buying term life insurance and investing the price difference.

Average universal life insurance rates

Rates are for a male with a Preferred (nonsmoker) classification, for $100,000 in coverage and no optional riders.

AGESMONTHLYYEARLY
20$36.19$434.38
30$42.00$504.00
40$62.74$752.93
50$89.50$1,074.09

Who should buy universal life insurance?

Similarly to other permanent life insurance policies, a universal life insurance policy is generally for people who have very specific needs. An individual with a high net worth may want to take advantage of the tax-deferred savings component, while parents of a child with special needs may need a universal policy due to the high costs associated with taking care of their child.

A universal life insurance policy is also a good fit for someone who is looking for some flexibility in their life insurance policy. Because it allows for adjustments in premium payments and the death benefit, you won’t have to sacrifice protection for your family if your financial health changes.

Universal life insurance vs term life insurance

Term life insurance is a simpler form of life insurance: you pay your premiums for a set term and your family will receive a death benefit if you die during that time. If you outlive the term and the policy expires, you’ll need to buy a new life insurance policy or your family won’t collect a death benefit when you die. The simplicity of term life insurance makes it cheaper than permanent life insurance policies and a better option for people that don’t require a life insurance policy with versatility.

Universal life insurance, like other types of permanent life insurance, differs from term life insurance in key ways:

  1. Universal life insurance is permanent; term life insurance lasts for a set period of time.
  2. Universal life insurance has a cash-value component; term life insurance cannot be considered a savings vehicle.
  3. Universal life insurance is 6 to 10 times more expensive than term life insurance.
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How universal life insurance compares to other permanent policies

Aside from universal life insurance, there are several other types of permanent life insurance policies to choose from, each differing in how the cash value can grow and be used.

Universal life insurance vs. whole life insurance

A whole life insurance policy offers a cash value component just as a universal life insurance policy does, but without the flexibility to adjust your payments if your financial situation changes. Due to its high cost, 45% of whole policies are abandoned within the first ten years of the policy, significantly decreasing the cash value.

FeatureUniversal lifeWhole life
DurationLifeLife
Guaranteed Death BenefitYes (But you can choose to adjust)Yes
Guaranteed Cash ValueProtected from risk, but can be depleted to pay premiumsYes
How Cash Grows (or Shrinks)Variable interest rate set by insurerEarns interest at a predetermined fixed rate
PremiumsVaries, up to the customer (subject to federal tax laws)Level

Universal life insurance vs. variable life insurance

Someone who is looking for more diversity when utilizing life insurance as a savings vehicle may consider a variable life insurance policy. Variable life insurance offers a range of investment options, including stocks, mutual funds, and bonds. Unlike universal life insurance, it doesn’t offer the same amount of premium payment and death benefit flexibility.

FeatureUniversal lifeVariable life
DurationLifeLife
Guaranteed Death BenefitYes (But you can choose to adjust)Yes
Guaranteed Cash ValueProtected from risk, but can be depleted to pay premiumsNo
How Cash Grows (or Shrinks)Variable interest rate set by insurerSub-accounts (pool of investor funds offered by the insurer)
PremiumsVaries, up to the customer (subject to federal tax laws)Level

Universal life insurance vs. variable universal life insurance

A variable universal life insurance policy is a combination of variable life insurance and universal life insurance. It allows for premium and death benefit adjustments, but has a more complex investing component.

FeatureUniversal lifeVariable Universal Life
DurationLifeLife
Guaranteed Death BenefitYes (But you can choose to adjust)Yes
Guaranteed Cash ValueProtected from risk, but can be depleted to pay premiumsProtected from risk, but can be depleted to pay premiums
How Cash Grows (or Shrinks)Variable interest rate set by insurerSub-accounts (pool of investor funds offered by the insurer)
PremiumsVaries, up to the customer (subject to federal tax laws)Varies, up to the customer (subject to federal tax laws)

Policygenius’ editorial content is not written by an insurance agent. It’s intended for informational purposes and should not be considered legal or financial advice. Consult a professional to learn what financial products are right for you.