Let me guess: you feel you’re banging your head against a wall when you need to understand what exactly is Universal life insurance.
So here is the point:
Universal life insurance (also referred to as UL policy) is a type of life insurance, which combines lifetime coverage with an investment opportunity.
This type of policy gives the insured a chance to gain cash value over time as long as they pay their premiums. The insured can use the gained cash value, which brings interest, to borrow from or other purposes.
Let's take a look at it in detail and compare it to some other similar policies.
How Does It Work?
Usually, UL policies are likened to the so-called whole life insurance (also known as permanent life insurance) and indeed they share many common features. UL coverage is more flexible, however, because the premiums you have to pay your insurer are two types and can be changed over the period.
Here’s how it goes:
- The first one is the cost of the policy, which guarantees the beneficiary will receive the money after the death of the owner.
- The second one is additional money, and it actually builds the so-called cash value (something like a savings account). The second part gives you plenty of room to maneuver.
For example, After a certain period of time, the accumulated savings can be used to cover the premium on the policy costs. You may even take out a loan using your savings.
In the event of death, the amount of the unpaid debt will be taken from the death benefit. Another crucial thing to know is that the cash value will not be paid out to the beneficiary upon the owner's death, only the insurance. The cash value will be used by the insurance company.
Universal vs Whole Life Insurance
These two types of policies are often compared. Unlike term life insurance, both universal and whole life policies offer lifetime coverage.
What are the main differences?
- The first difference is the cost of insurance (COI). While whole life insurance offers a fixed premium over the whole period, UL policies do not. As time passes, the cost of insurance of UL coverage increases.
- The second difference is the flexibility a UL policy offers. The premium on whole life insurance is fixed and cannot change. Besides, you cannot miss payments without risking your policy. On the other hand, universal life insurance allows people to change the amount of money they owe, and even reduce it. In addition, you can also miss a payment. Without risking termination of the policy.
- Last but not least, cash value. In fact, this is what makes UL insurance so attractive: the chance to gain cash value. Many people think this is a great investment opportunity because it gives the chance to gain some interest on the amount.
Guaranteed vs Assumptive Interest Rate
Here you have to be aware of two interest rates: guaranteed and assumptive.
The latter is the rate that your insurer will show you and try to tempt you with. This is a rate that is expected or might be in ideal market conditions. Or with one word: hypothetical. Be careful, this rate is often unachievable and its pure purpose is to make your sign the policy.
In fact, the real interest rate you have to be looking at is the guaranteed interest rate, which will be written down in your contract. This is the minimum guaranteed interest you will be earning on your cash value. Rarely does the rate on your insurance surpass the guaranteed interest rate.
The good news
Usually, when interest rates are low, the performance of insurance policies is weak. Now that the Fed has raised twice interest rates this year and is planning to do it again by the end of the year, we expect an upward trend.
Monitor The Cash Value
One of the most important thing in a UL policy is the cash value.
Regardless of the type UL insurance, the cash value is a certain component of the policy. In the beginning, the cash value is greater and it will cover the two premiums. It's necessary to fund the policy over the whole period because the cash value, if you don't refund, will be gone sooner or later.
Here’s the secret:
You should always monitor the current status of your cash value. Don't forget that your premiums will increase over time and as you get older. You shouldn't wait until you exhaust your cash value and it shows zero. Your insurer, if such situation arises, will notify you for sure if you want your policy and contract to remain active. However, keep in mind that often they will ask for a much higher rate to keep the policy active.
It won't be pleasant to hear that your insurer has increased the cost of your coverage or the cash value is going down. What can you do? To start with, you can sign a new policy
Cash Value – Loans And Fees
One of the things you can do with your cash value is taken out a loan. It's like borrowing from yourself, but not exactly. The company that issued your policy will certainly charge a fee that may reach 10%. This is called “cash surrender fee.”
The fee will not be the only thing charged if you take a loan out of your own cash account. Certainly, the insurance company will charge an interest rate between 5-9%. It's strange to pay so much using your own money, but it's true. Also, because of the loan, the amount of the death benefit will be reduced until you pay it off.
Guaranteed Universal Life Insurance (GUL)
Another thing you can do is to secure a term or guaranteed UL insurance policy ( GUL). The latter is very appropriate since it offers coverage until age 90, 95 and even beyond. Often times customers outlive their term life policy.
Keep in mind:
This type of policy does not offer the opportunity to build cash value, which is a drawback. Just like term insurance, GUL gives customers a fixed rate during the whole period. The longer the period, the more chances of a death benefit. This, of course, will be on account of higher costs.
As of late, GULs have become very attractive and customers tend to opt for this type of policy. As discussed in the previous paragraph, they can provide coverage until age 120 as well as a lock in rates. This is, however, costly. The least expensive and most affordable type of policy is term life insurance. Term policies offer coverage for a set period of time.
In any case, you should be careful with your GUL because some of the guarantees may disappear if you don't make payments on time.
Pros and Cons of UL policy
- Offers more flexibility than whole life insurance
- Lifetime coverage
- Accumulation of cash value
- Variable-rate on cash value which might bring a higher return
- No guaranteed premiums; they usually increase over time
- Variable rates mean also that the rate on your cash value might go down
- You need to have cash value in order to keep the policy active
- The beneficiary does not receive the cash value after the policy owner's death
- High management fees
At first sight, universal life insurance looks as something very seductive. It gives a lifetime coverage, flexible premiums and accumulates cash value. The cash value gains interest over time and plays the role of a savings account.
However, the rates are not fixed – they might go up or down depending on many factors. Therefore, if you have decided to choose this type of policy, you had better keep an eye on your guaranteed interest rate. This is the minimum rate at which your cash value will gain interest.
On the other side of the coin, a UL policy costs more than the other types– the older you get, the higher the premium. What's more, as time passes, the size of your cash value will decrease. If you exhaust the cash value, the policy may not be active anymore. One more thing: your beneficiary will not see the cash value. Once the owner dies, it is not part of the death benefit.
After these considerations, many experts advise people to use term life insurance policies and put their investments in savings accounts.
They think that it's wise to keep your investments and insurance separate. Thus, it will be cheaper, safer and you will not lose money.