Universal Life Insurance
Universal Life Insurance
Universal Life Insurance (UL), also called “Flexible Premium Adjustable Life Insurance,” entered the life insurance market in the early 1980s as a more flexible version of Whole Life Insurance. Like Whole Life, Universal Life Insurance features a savings element that grows on a tax-deferred basis. A portion of your premiums are invested by the insurance company in bonds, mortgages and money market funds. The return on the investments is credited to your policy tax-deferred. A guaranteed minimum interest rate applied to the policy (usually around 4%) means that, no matter how the investments perform, the insurance company guarantees a certain minimum return on your money. If the insurance company does well with its investments, the interest rate return on the accumulated cash value will increase. Universal Life allows you to choose from two death benefit options. Option A pays the death benefit out of the policy’s cash value; the more cash value you build up means the company is on the hook for less insurance (and therefore costs less). Option B pays the face amount stated in the contract, plus any cash values you accumulated over the years (costs more). Many Universal Life Insurance policies today offer a no-lapse guarantee: as long as you pay the minimum designated premium, the policy will stay in force to age 100 (or even to age 120). However, paying the minimum guaranteed premium is rarely sufficient to build up significant cash values. In summary: Universal life insurance is a “flexible premium, adjustable life insurance policy”. Universal life insurance policies are characterized mainly by their flexibility in
- death benefits, and
- access to cash value.
Universal life insurance is very different from traditional whole life insurance policies. Rather than the rigid rules of whole life insurance under which a policy owner must pay billed premiums no later than the end of the grace period or risk policy lapse, a universal life insurance policy owner can pay
- billed premiums;
- more than the billed premiums;
- less than the billed premiums;
- no premium.
Further, the policy owner may pay a premium at some time other than when billed. Under a Universal Life Insurance Policy, the policy owner has complete freedom concerning how much premium to pay and when to pay it. Universal life insurance represents a significant change from the traditional fixed premium whole life insurance products that preceded it. Earlier life insurance products were characterized by inflexibility in premiums, cash value, and death benefit. If the policyowner wants to reduce the premium for a whole life insurance policy, it is necessary to reduce the face value of the policy through a partial surrender of the policy. Unfortunately, this can result in the release of cash value to the policyowner and possible income tax liability. Universal life insurance policies unlock the connection between premium, face amount and cash value. Despite the premium flexibility, of universal life insurance, there are certain rules that apply to premium payments. Although a policyowner may choose to pay no premium into the policy on a particular premium-due date, any payments that are made must meet a certain minimum to help the carrier to manage the costs of premium collection and processing. There are three premiums normally associated with universal life insurance policies:
- Minimum premiums,
- Target premiums
- Maximum premiums.
The minimum premium is the premium that, if paid each year, would generally be just enough to keep the policy in force for one more year without the accumulation of any cash value. The universal life insurance target premium is generally the amount of premium that will keep the policy in force for the insured’s lifetime. There is, however, no guarantee that the universal life insurance policy will remain in force for that period if only the target premium is paid. In fact, there is no guarantee that the universal life insurance policy will remain in force regardless of the premium level that is maintained by the policy owner. The maximum premium is the largest permitted premium that will enable the universal life insurance policy to maintain its character as life insurance. If you pay additional premiums, then the policy will be considered a “Modified Endowment Contract” or MEC. MECs lose much of the tax advantages of life insurance. No Lapse Guaranteed Universal Life Insurance Policies have a defined premium level at which the carrier guarantees that the policy will remain in force even if the cash value should dip below zero and the policy would otherwise lapse. Pros: Universal Life gives you the flexibility to adjust the death benefit as your needs change, as well as the flexibility to pay smaller or larger premiums – depending on your financial circumstances. This is often an important feature for families who may have fluctuations in their ability to pay. Cons: If your premium payments are too small for too long, the policy could lapse, leaving you without insurance protection. Also, if the insurance company does poorly with its investments, the interest return on the cash portion of the policy will decrease (but never below the minimum interest rate guaranteed in the contract). In this case, cash values will probably fall, forcing you to pay more premium in the later years.