Universal life insurance is a flexible type of permanent life insurance policy that comes with a cash value component. It allows you to increase or decrease how much you pay toward premiums, and even cover those payments using the policy’s cash value.
A universal life policy can be a good fit for someone who is looking for some flexibility in their life insurance — and can afford that flexibility. It’s best for high earners who are trying to build a nest egg without entering a higher income bracket.
What is universal life insurance?
What makes universal life different from other types of permanent life insurance is that it allows you to use the cash value to pay your premiums. But similar to other permanent policies, it lasts your entire life and pays out a tax-free death benefit to your beneficiaries when you die.
Part of the premiums you pay goes toward the death benefit, while the remainder is contributed toward the cash value of your policy, which earns a small amount of variable interest and isn’t taxed while it grows.
While you’re alive, you can use the cash value to:
Cover the cost of your policy premiums
Withdraw cash, but with additional fees
Take out a loan, which you’ll have to pay back with interest
The cash value grows tax-deferred, and you only pay taxes on the gains you make if you withdraw more than what you paid into the policy in premiums, otherwise known as the cost basis, or policy basis.
The best universal life insurance options
The best three policies that fall under the universal life umbrella are:
Guaranteed universal life insurance: Guarantees a death benefit payout and uniform premium payments for the duration of the policy. Guaranteed universal life insurance is one of the most affordable and convenient types of permanent life insurance.
Indexed universal life insurance: Provides the opportunity for stock market gains. Indexed universal life insurance is the most common type of life insurance policy people add to their investment portfolio. Its cash value component has a minimum (and maximum) guaranteed interest rate — so if you’re purchasing the policy to enhance your investment portfolio, you’ll know that you’re never losing money.
Variable universal life insurance: Provides the policyholder more investment options. You can invest in mutual funds that can increase or decrease the cash value. Variable universal life insurance is another type of permanent life insurance with flexible premiums, an adjustable death benefit, and several options for investing the cash value.
How does universal life insurance work?
Universal life insurance allows you to adjust your premiums and death benefit depending on your needs. If, after some time, you decide to stop paying or lower your monthly premiums, you can use the cash value to pay them. However, you can’t do this until it has accrued enough interest.
“For you to really start to see the fruits of your labor or a decent rate of return it takes years,” says Malik S. Lee, Managing Principal at Felton & Peel.
And if the policy’s investments underperform, you’ll need to resume making your premium payments. If you completely deplete your policy’s cash value and still don’t make a premium payment, your policy will lapse.
Because universal life provides permanent coverage, some people choose it for their estate planning needs. The death benefit payout can be used to cover estate taxes.
How cash value in universal life insurance works
How your cash value grows depends on the specific type of universal life insurance policy you have.
In a traditional universal life insurance policy, for example, an insurer may set the rate of return on universal life insurance at 2%, while the rate of return on an IRA or 401(k) that matches historical stock market averages is around 10%. 
The lower rates of return on a universal life insurance policy are why many financial advisors recommend buying term life insurance and investing the difference. Plus, the fluctuating interest rates mean you’ll need to monitor your policy yearly. Not doing so can mean paying for a universal life insurance policy that is unaffordable.
Alternatively, in an indexed universal life insurance policy, the interest earned on the cash value is based on market index performance, such as the S&P 500, and is subject to market fluctuations. Your policy’s index depends on your insurer, as is the floor and cap on gains set by insurers.
“The floor is almost always 0%. The cap for every product is different, but it’s usually between 8% and 13%,” says Patrick Hanzel, certified financial planner and advanced planning team manager at Policygenius.
This means that universal life insurance isn’t always the best option to save money for the future. While you won’t lose money, the capped returns realize a much smaller gain than you could get by investing the same amount in an IRA or 401(k).
Average cost of universal life insurance
The actual cost of universal life insurance isn’t fixed when you buy it, making it financially risky. Because universal life insurance policies are permanent and accrue cash value, the premiums are a lot higher.
It can be difficult to create a long-term budget for this type of policy because of its flexible premiums. And before your policy builds up cash value, you’ll be paying a lot of money to have that flexibility.
Additionally, the cost of a universal life insurance policy usually increases over time — on a policy that already has minimal investment guarantees — so it’s not the best vehicle for asset accumulation. You can get a universal life insurance quote from a licensed life insurance agent.
Who should buy universal life insurance?
Universal life products are for high-net-worth individuals with very specific tax or investment needs. If you have maxed out all other investment components, for example, you could benefit from adding a universal life insurance policy to your portfolio.
If you’re a very high earner, you may consider adding a universal life policy to your financial toolkit because it can help you build a nest egg without entering an even higher tax bracket.
“Typically the people that are doing this strategy, they’ve kind of exhausted all other avenues already,” says Lee.
“You need to go through — what I call — the savings hierarchy. You need to look at your most tax-efficient investment and saving tools first. Next, you have your tax-deferred vehicles. Lastly, you need to look at your taxable accounts — your life insurance strategies [for example],” says Lee. “Life insurance is the third option for me.”
Comparing universal life insurance and variable life insurance
The table below shows how universal life and variable life insurance differ.
Traditional universal life insurance
Variable life insurance
Guaranteed death benefit
Guaranteed cash value
Protected from risk, but can be depleted to pay premiums
How cash grows (or shrinks)
Guaranteed minimum interest rate
Sub-accounts — pool of investor funds offered by insurer
Varies, up to the customer (subject to federal tax laws)
Differences between universal life insurance and variable life insurance
The cash value grows differently: Both universal life insurance and variable life insurance have unpredictable interest rates — they change based on the market. With variable life insurance, you choose which sub-accounts grow your cash value, but you’re still subject to an unpredictable market, and there’s no guaranteed minimum rate.
Universal life has flexible premium payments: Universal life is unique because you can use the cash value growth toward premium payments. If you have enough cash value growth, you may not need to pay any premiums at all.
How to get universal life insurance
A Policygenius agent can work with you for free to get you the right policy for your needs. If a universal life insurance policy is best suited for your financial situation, an agent will help you customize the policy to your ideal price point.
Is universal life insurance worth it?
A universal life insurance policy is very expensive, and for most people, purchasing a term life insurance policy and investing the difference in an IRA, 401(k), or traditional investments provides greater returns for a lower cost.
But for individuals in a high tax bracket, a universal life insurance policy can offer a tax-deferred asset accumulation option that also protects the financial security of their loved ones.