What is universal life insurance & how does it work?

A universal life insurance policy offers permanent coverage and the flexibility to adjust your premiums and death benefit. It can be a good fit for high earners looking for options to build a tax-free inheritance for their family or retirement income.

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Tory CrowleyAssociate Editor & Licensed Life Insurance AgentTory Crowley is an associate editor and a former licensed insurance agent at Policygenius. Previously, she worked directly with clients at Policygenius, advising nearly 3,000 of them on life insurance options. She has also worked at the Daily News and various nonprofit organizations.&Katherine MurbachEditor & Licensed Life Insurance AgentKatherine Murbach is an editor and a former licensed life insurance agent at Policygenius. Previously, she wrote about life and disability insurance for 1752 Financial, and advised over 1,500 clients on their life insurance policies as a sales associate.

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Antonio Ruiz-CamachoAntonio Ruiz-CamachoAssociate Content DirectorAntonio helps lead our life insurance and disability insurance editorial team at Policygenius. Previously, he was a senior director of content at Bankrate and CreditCards.com, as well as a principal writer covering personal finance at CNET.
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Maria FilindrasMaria FilindrasFinancial AdvisorMaria Filindras is a financial advisor, a licensed Life & Health insurance agent in California, and a member of the Financial Review Council at Policygenius.

Updated|7 min read

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Universal life insurance (UL) is a type of permanent life insurance policy that doesn’t expire as long as you pay your premiums and comes with a cash value component. It’s different from other popular permanent options, like whole life insurance, because it allows you to increase or decrease how much you pay toward premiums — and you can even cover those payments using the policy’s cash value.

Some UL policies may also allow you to adjust the death benefit on your policy. On the other hand, you need to keep an eye on the performance of your cash value. If it decreases to a point where you don’t have enough funds to cover your premiums, your policy may lapse — in other words, it may be canceled and you’ll lose coverage.

Key takeaways

  • Universal life insurance (UL) is a type of permanent life insurance that doesn’t expire as long as you pay your premiums and comes with a cash value component.

  • UL allows you to lower or increase your premiums, and even use your cash value to cover your premiums. 

  • UL insurance can be a good option for high earners, but for most people, a term life insurance policy combined with a separate investment account is a more affordable option.

How does universal life insurance work?

Universal life insurance allows you to adjust your premiums and death benefit depending on your needs. After some time, you’ll be able to lower or even stop paying your monthly premiums using your cash value if you choose to. 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 [in a universal life insurance policy] 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 use up your policy’s cash value and don’t resume paying your premiums, your policy will lapse. In other words, it will get canceled and you’ll lose coverage.

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 

The cash value account is an important part of a UL policy. 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 at 2%, while the rate of return on an IRA or 401(k) that matches historical stock market averages is around 10%. [1]

The lower rates of return on a UL policy are the reason why many financial advisors recommend buying term life insurance and investing the difference in more traditional investment accounts, like index funds or even a high-yield savings account. 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.

“The floor [for many UL policies] 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) plan. 

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Pros and cons of universal life insurance

Pros

  • Flexible premiums

  • Flexible death benefit

  • Cash value growth

  • Allows for policy loans

Cons

  • Higher risk of policy lapse

  • Returns are not guaranteed

  • Some withdraws can be taxed

  • High administrative fees

Advantages of universal life insurance

Flexible premiums

Most insurance policies offer fixed premiums, but with universal life, you can use the cash value of your policy to lower the premiums you’ll pay. This is only possible if you pay excess premiums which increase the value of the cash value account. This account will grow with interest, and you can use the excess amount to lower your premiums if you choose to.

Flexible death benefit

Similarly, universal life insurance policies allow you to use excess cash value to increase your total death benefit. In most cases, you can also lower the death benefit if you need to pay lower premiums to keep the policy active. 

Cash value growth

Many permanent life insurance policies, including universal life, come with a cash value component. The cash value works similar to a savings account, where a portion of your premiums goes to the account, which also grows with interest. As the cash value increases, you can withdraw from the account or take loans against it while you’re still living. 

Allows for policy loans

Once your cash value reaches a certain threshold, you can take loans against it. Taking out a loan against the cash value doesn’t require a background check or formal application (like you would have to do with a bank loan) and you don’t pay taxes on the money you get. If you die before you pay back the loan, the outstanding amount will be taken from the death benefit. 

Disadvantages of universal life insurance

Higher risk of policy lapse

The flexibility that comes with a universal policy requires more management than other types of insurance. If you lower your premiums or withdraw from your cash value, you have to make sure that your cash value never falls to zero and your premiums are always paid. This can be challenging for some people and policies can lapse due to negligence or mismanagement. 

Returns are not guaranteed

Cash values of universal life policies don’t have a guaranteed rate of interest. This means that if interest rates drop, your cash value may not increase very quickly, and you would have been better off investing your money elsewhere. The flip side of this is that most UL policies come with a guaranteed minimum rate of growth, which can provide stability to your account.

Some withdraws can be taxed

If you withdraw more money from your cash value than what you’ve paid in, this amount will be considered a taxable income. If you withdraw less than what you’ve paid in, this amount won’t be taxed.

→ Is life insurance taxable?

High administrative fees

Because universal life policies require more management than other policies, they come with higher administrative fees. More of each premium you pay will go to cover these fees, relative to other types of insurance. 

Universal life insurance vs. term life insurance vs. whole life insurance

Universal life is different from term and traditional whole life insurance. 

  • Both universal life and whole life offer lifelong coverage and a cash value account. Term life insurance, on the other hand, expires after a set term and only offers basic protection in the form of a death benefit. 

  • Premiums for universal life are usually lower than whole life insurance but higher than premiums for term life insurance. 

  • Whole life insurance is more expensive than both term and universal life insurance, but still offers a permanent death benefit.

  • Unlike universal life, whole life insurance comes with fixed premiums and a fixed death benefit. While whole life is less flexible than UL, it’s also easier to manage.

Universal life insurance

Term life insurance

Whole life insurance

Coverage length

Permanent

Lasts for a set time or term

Permanent

Cash value

Flexible, not guaranteed growth

No cash value 

Fixed, guaranteed growth

Premiums

Flexible, more expensive than term

Fixed, much more affordable than UL & whole life

Fixed, much more expensive than term, higher than UL

Which is better: whole life or universal life insurance?

If you’re looking for permanent coverage with a guaranteed death benefit and cash value, whole life insurance can work for you. If you desire flexibility and are able to be involved in monitoring your policy’s cash value, UL can be a good fit for you. 

Average cost of universal life insurance

The actual cost of universal life insurance isn’t fixed when you buy it, so this type of insurance carries more risk than others. And because UL policies are permanent and accrue cash value, the premiums are a lot higher than a comparable term life policy. 

Because of its flexible premiums, if you’re on a budget, it can be difficult to plan for the cost of this type of policy. And before your policy builds up cash value, you’ll be paying a lot of money for 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. To get a better estimate of the cost of universal life insurance, get a universal life insurance quote from a licensed life insurance agent.

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Who should buy universal life insurance?

If you’re a 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 a higher tax bracket. 

“Typically the people that are doing this strategy, they’ve kind of exhausted all other avenues already,” says Lee of Felton & Peel.

“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.”

It’s only after you’ve maxed out all other investment components that you’ll benefit from adding a UL policy to your portfolio. This makes universal life products beneficial only for high-net-worth individuals with very specific tax or investment needs

Is universal life insurance worth it?

A universal life insurance policy is more expensive than other types of insurance. 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 if you’re 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 your loved ones. 

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.

Other universal life insurance options

Frequently asked questions

What are the benefits of universal life insurance?

There are four major benefits to traditional universal life insurance: 

  1. It lasts your entire life.

  2. It accrues cash value at an interest rate that won’t drop below 0%.

  3. The cash value accrual is tax-deferred.

  4. Premium payment amounts can be decreased.

  5. The cash value can be used to cover premiums.

What are the disadvantages of universal life insurance?

There are some major disadvantages to universal life insurance that make it not worth buying:

1. It’s a lot more expensive than term life insurance.

2. The actual cost of insurance increases with time. 

3. Using cash value to pay for premiums risks a policy lapse.

Is universal life insurance a good investment?

Universal life insurance isn’t a good investment for most people, but high earners may find it useful to grow tax-deferred savings.

What is the difference between whole life insurance and universal life insurance?

With a whole life insurance policy, you can’t use the cash value to pay your policy’s premiums, but with universal life insurance you can. Whole life insurance also comes with fixed premiums and a fixed death benefit. Universal life insurance allows you to adjust your premiums and your death benefit.

References

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Policygenius uses external sources, including government data, industry studies, and reputable news organizations to supplement proprietary marketplace data and internal expertise. Learn more about how we use and vet external sources as part of oureditorial standards.

  1. Financial Industry Regulatory Authority

    (FINRA). "

    The Reality of Investment Risk

    ." Accessed October 26, 2023.

Authors

Tory Crowley is an associate editor and a former licensed insurance agent at Policygenius. Previously, she worked directly with clients at Policygenius, advising nearly 3,000 of them on life insurance options. She has also worked at the Daily News and various nonprofit organizations.

Katherine Murbach is an editor and a former licensed life insurance agent at Policygenius. Previously, she wrote about life and disability insurance for 1752 Financial, and advised over 1,500 clients on their life insurance policies as a sales associate.

Editor

Antonio helps lead our life insurance and disability insurance editorial team at Policygenius. Previously, he was a senior director of content at Bankrate and CreditCards.com, as well as a principal writer covering personal finance at CNET.

Expert reviewer

Maria Filindras is a financial advisor, a licensed Life & Health insurance agent in California, and a member of the Financial Review Council at Policygenius.

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