Universal life insurance (UL) is a hybrid life insurance policy which combines elements of term life insurance with an investment savings option. Universal life combines the ability to build savings at the same time as providing you a life insurance policy. This allows flexibility in what you can do with the savings or investment portion of the premium. Universal life insurance also contains an element of long-term investment strategy because it required you build the values in the investment portion through part of the amount you pay monthly.
Universal Life Insurance Options: Indexed Universal Life Insurance (IUL) vs UL
The success of a universal life insurance plan depends greatly on the investments in the plan you choose and market performance. In past years, there were concerns with the values in the investment portion of Universal Life Insurance because of unstable markets. As a result, indexed universal life insurance (IUL) evolved to address concerns with changing markets and some of the problems faced in the past by those who had purchased universal life in the past few decades. When considering universal life insurance, IUL seems to provide more safety than UL. It would be important to ask your financial planner about these options and see how they fit your needs and long term strategy.
How Does Universal Life Insurance Work?
A portion of the universal life insurance monthly premium is put into the cost of the life policy which will provide the death benefit to your beneficiary and another portion of the premium is invested so it can be used as investment savings.
The concept is that the investment will grow over time and eventually may even be able to pay for the premiums of the life portion of the policy. The advantage in this situation would be that you could pay into for a certain number of years and the investments would eventually start to cover the cost of the premium, then you end up getting life insurance for whole life, yet don’t need to keep making those payments.
Understanding Universal Life Insurance and Cash Value
Universal life insurance policies provide an option for a life insurance death benefit while helping you build savings that can be cashed out, or moved from the investment portion of the policy to the life insurance premium of the policy as your conditions in life change. Cash value life insurance policies like a universal life insurance policy may also be used as vessels to save money for other larger investments, like saving for a down payment on your first home.
When to Buy Universal Life Insurance
Buying Universal life insurance early on in life, like your 20’s or 30’s will allow the greatest opportunity to build your assets.
The concept of the universal life insurance policy would be to have it for at least 10-15 years before you start to cash out or shift investments. If you purchase a universal life policy in your twenties, you could be secured to have a policy for life by the time you settle down and have kids, and you might even be able to use the asset portion as a down payment on your first home. However, this all depends on the type of universal life you choose and the market performance. Keep in mind that when purchasing life insurance when you are younger, you will benefit from lower rates, so if you think life insurance is expensive now, remember that it will only cost more as you get older.
Your overall life strategy should come into play when you decide on life insurance.
Universal Life Insurance as a Strategy to Build Wealth and Maintain a Death Benefit
A universal life insurance policy allows you to build your wealth while assuring that you have a solid life insurance policy in place. as opposed to term life insurance.
The major advantage of the universal life insurance policy is the potential to not have to pay life insurance premiums for life, yet still be insured into your retirement. As you get older and have more financial responsibilities, being able to cut down on costs like life insurance is a definite advantage. If you are older, then a universal life policy may not make as much sense as a whole life policy which is a safer investment and provides additional advantages.
Beware: Universal Life Insurance Depends on Market Stability to Work Properly
Although the traditional version of universal life insurance was a popular and safe option a couple of decades ago, as the financial situation of the past two decades has seen periods of instability, the advantages of the traditional universal life policy have diminished and become more risky. Universal Life is different than term life insurance because of the investment factor of the premiums. If the premiums are invested into unstable markets, then your entire investment could be at risk.
Two Kinds of Universal Life Insurance:
Traditional Universal Life Insurance (UL)
Indexed Universal Life Insurance (IUL)
Due to the fluctuations in the stock markets, the traditional UL insurance model may be too risky, therefore if you are looking at a life insurance option that will help you with savings, then make sure and discuss the effects your investment portion will have if the stock market is in a downturn. IUL may be a safer option.
The Advantage of Indexed Universal Life (IUL) and What You Need to Know About It
Many people lost their life insurance policy or investments when they invested in a traditional universal life policy in the past 20-30 years, however the new indexed universal life policy has been developed to provide safer options. Choosing a smart policy will help you build your assets and build your wealth while securing a death benefit for your beneficiary.
Indexed Universal Life Insurance
If you purchase universal life insurance early in life it can afford a great opportunity to build savings with variable interest rates, flexibility and cash out options. Along with providing a death benefit, universal life insurance also incorporates a savings vehicle. In short, it is like combining a term life insurance policy with a tax-deferred interest accumulating savings account.
Make sure you have a knowledgeable insurance agent to review your other options such as term and whole life insurance. Universal life insurance is a choice that requires some research and solid financial planning advice. Discuss what happened with universal life insurance in the past, to understand how you will avoid the downfalls of what too many people went through when the markets turned. It is important to feel comfortable with your decision. It’s your money and a good strategic plan will build your wealth, a poor decision could cost you thousands.
Similar life insurance types
A similar type of policy that was developed from universal life insurance is the variable universal life insurance policy (VUL). VUL lets the cash value be directed to a number of separate accounts that operate like mutual funds and can be invested in stock or bond investments with greater risk and potential growth. Additionally, there is the recent addition of indexed universal life contracts similar to equity-indexed annuities which credit interest linked to the positive movement of an index, such as the S&P 500, Russell 2000, and the Dow Jones. Unlike VUL, the cash value of an Index UL policy generally has principal protection, less the costs of insurance and policy administrative fees. Index UL participation in the index may have a cap, margin, or other participation modifier, as well as a minimum guaranteed interest rate.
Universal life is similar in some ways to, and was developed from, whole life insurance, although the actual cost of insurance inside the UL policy is based on annually renewable term life insurance. The advantage of the universal life policy is its premium flexibility and adjustable death benefits. The death benefit can be increased (subject to insurability), or decreased at the policy owner’s request.
The premiums are flexible, from a minimum amount specified in the policy, to the maximum amount allowed by the contract. The primary difference is that the universal life policy shifts some of the risk for maintaining the death benefit to the policy owner. In a whole life policy, as long as every premium payment is made, the death benefit is guaranteed to the maturity date in the policy, usually age 95, or to age 121. A UL policy lapses when the cash value is no longer sufficient to cover the insurance and policy administrative expense.
To make UL policies more attractive, insurers have added secondary guarantees, where if certain minimum premium payments are made for a given period, the policy remains in force for the guaranteed period even if the cash value drops to zero. These are commonly called no lapse guarantee riders, and the product is commonly called guaranteed universal life (GUL, not to be confused with group universal life insurance, which is also typically shortened to GUL).
The trend up until 2007–2008 was to reduce premiums on GUL to the point where there was virtually no cash surrender values at all, essentially creating a level term policy that could last to age 121. Since then, many companies have introduced either a second GUL policy that has a slightly higher premium, but in return the policy owner has cash surrender values that show a better internal rate of return on surrender than the additional premiums could earn in a risk-free investment outside of the policy.
With the requirement for all new policies to use the latest mortality table (CSO 2001) beginning January 1, 2004, many GUL policies have been repriced, and the general trend is toward slight premium increases compared to the policies from 2008.
Another major difference between universal life and whole life insurances: the administrative expenses and cost of insurance within a universal life contract are transparent to the policy owner, whereas the assumptions the insurance company uses to determine the premium for a whole life insurance policy are not transparent.
Uses of universal life insurance
Final expenses, such as a funeral, burial, and unpaid medical bills
Income replacement, to provide for surviving spouses and dependent children
Debt coverage, to pay off personal and business debts, such as a home mortgage or business operating loan
Estate liquidity, when an estate has an immediate need for cash to settle federal estate taxes, state inheritance taxes, or unpaid income taxes on income in respect of a decedent (IRD).
Estate replacement, when an insured has donated assets to a charity and wants to replace the value with cash death benefits.
Business succession & continuity, for example to fund a cross-purchase or stock redemption buy/sell agreement.
Key person insurance, to protect a company from the economic loss incurred when a key employee or manager dies.
Executive bonus, under IRC Sec. 162, where an employer pays the premium on a life insurance policy owned by a key person. The employer deducts the premium as an ordinary business expense, and the employee pays the income tax on the premium.
Controlled executive bonus, just like above, but with an additional contract between an employee and employer that effectively limits the employee’s access to cash values for a period of time (golden handcuffs).
Split dollar plans, where the death benefits, cash surrender values, and premium payments are split between an employer and employee, or between an individual and a non-natural person (e.g. trust).
Non-qualified deferred compensation, as an informal funding vehicle where a corporation owns the policy, pays the premiums, receives the benefits, and then uses them to pay, in whole or in part, a contractual promise to pay retirement benefits to a key person, or survivor benefits to the deceased key person’s beneficiaries.
An alternative to long-term care insurance, where new policies have accelerated benefits for Long Term Care.
Mortgage acceleration, where an over-funded UL policy is either surrendered or borrowed against to pay off a home mortgage.
Life insurance retirement plan, or Roth IRA alternative. High income earners who want an additional tax shelter, with potential creditor/predator protection, who have maxed out their IRA, who are not eligible for a Roth IRA, and who have already maxed out their qualified plans.
Term life insurance alternative, for example when a policy owner wants to use interest income from a lump sum of cash to pay a term life insurance premium. An alternative is to use the lump sum to pay premiums into a UL policy on a single premium or limited premium basis, creating tax arbitrage when the costs of insurance are paid from untaxed excess interest credits, which may be crediting at a higher rate than other guaranteed, no risk asset classes (e.g. U.S. Treasury Bonds or U.S. Savings Bonds).
Whole life insurance alternative, where there is a need for permanent death benefits, but little or no need for cash surrender values, then a current assumption UL or GUL may be an appropriate alternative, with potentially lower net premiums.
Annuity alternative, when a policy owner has a lump sum of cash that they intend to leave to the next generation, a single premium UL policy provides similar benefits during life, but has a stepped up death benefit that is income tax-free.
Pension maximization, where permanent death benefits are needed so an employee can elect the highest retirement income option from a defined benefit pension.
Annuity maximization, where a large non-qualified annuity with a low cost basis is no longer needed for retirement and the policy owner wants to maximize the value for the next generation. There is potential for arbitrage when the annuity is exchanged for a single premium immediate annuity (SPIA), and the proceeds of the SPIA are used to fund a permanent death benefit using Universal Life. This arbitrage is magnified at older ages, and when a medical impairment can produce substantially higher payments from a medically underwritten SPIA.
RMD maximization, where an IRA owner is facing required minimum distributions (RMD), but has no need for current income, and desires to leave the IRA for heirs. The IRA is used to purchase a qualified SPIA that maximizes the current income from the IRA, and this income is used to purchase a UL policy.
Creditor/predator protection. A person who earns a high income, or who has a high net worth, and who practices a profession that suffers a high risk from predation by litigation, may benefit from using UL as a warehouse for cash, because in some states the policies enjoy protection from the claims of creditors, including judgments from frivolous lawsuits.