Universal life insurance is a type of permanent life insurance policy. A permanent life insurance policy is a policy that lasts a policyholder's entire life. There is a death benefit paid out to beneficiaries and a cash value that builds up over time.
Universal Life insurance is one of the most popular types of permanent life insurance. The other popular type of permanent life insurance is whole life.
This article will focus on defining universal life insurance, comparing universal life to whole life, and describe how both works.
What Is Universal Life Insurance?
Universal life insurance is one of the most common types of permanent life insurance policies. It offers flexible premiums that may allow you to adjust how much you'll pay each year by accessing some of the policy's cash value.
Depending on your policy's potential cash value, it may be used to skip a premium payment, or be left alone with the potential to accumulate even greater value over time.
When you buy a universal life insurance policy, the issuing insurance company establishes a minimum interest crediting rate as outlined in your contract. In other words, you will get a minimum guaranteed return on the cash value portion of your policy.
However, if the insurer's portfolio earns more than the minimum interest rate, the company will more than likely credit the policyholder excess interest to your policy. Therefore, during good economic times, a universal life policyholder may grow his or her cash value quicker than a whole life insurance policyholder who has a more fixed rate of return.
A universal life insurance policy is a good choice for people who want:
- Flexibility to adjust their premiums and coverage amounts
- Cash value that can be borrowed from while still alive
- A permanent life insurance protection plan with access to cash values
- People who have strong cash flow, high incomes, and will likely surpass the estate tax exemption amount
What is Whole Life Insurance?
Universal life is often compared with whole life insurance. They are similar, but people get the two mixed up all the time.
The main difference between the two is that whole life insurance policies have a fixed premium, meaning you pay the same amount each and every month or year for your coverage. A whole life insurance policy also has a death benefit and a cash value that can grow over time. The cash value can be borrowed against.
The benefit of taking a whole life insurance policy is that you pay the same premium over the entire life of the policy. As your income and net worth grows, the relative cost to own your whole life insurance policy decreases. For retirement planning purposes, it's nice to know what your expenses are.
Your cash value still gets to accumulate and be used while you're alive. And you get permanent life insurance protection, no matter what happens during your life that might increase your premiums if you didn't have a permanent life insurance policy.
Again, the level premium is very important because as we get older and less healthy, premiums go up if you don't already have life insurance.
Downside Of Whole Life Insurance
However, the potential downside to a whole life insurance policy is that it guarantees a fixed rate of return on the cash value. If you were able to lock in a high guaranteed rate of return while interest rates are high, you'll do better than if you locked in a guaranteed rate of return when interest rates were low. But it's hard to control timing.
Currently, interest rates are high after the Fed hiked rates 11 times since 2022. So locking in universal life insurance now is a better deal. But things change.
Further, even if you have a guaranteed high interest rate for your cash value, if there's a raging bull market for decades, you will have missed out on further gains. This is where a variable universal life comes in. With variable universal life, the cash value is invested in various accounts of stocks, bonds or mutual funds that may go up further over time.
Universal Life Insurance Benefits
Although whole life insurance has a fixed premium and fixed guaranteed rate of return, universal life insurance allows for a variety of different payment options and the ability to change death benefit amounts.
Here is some of the flexibility that universal life insurance offers:
- The cash value component, once built up large enough, can allow you to skip premium payments. If you wish, you just use the cash value to pay for the premiums instead.
- Some universal life insurance policies may allow you to increase or decrease the death benefit to match your particular circumstances.
- In most cases, you can borrow against the cash value that may have accumulated in the policy for various things.
- The interest that you may have earned over time accumulates tax-deferred, which is similar to whole life insurance.
Universal Life Insurance Provides More Flexibility
The flexibility of a universal life policy is the main attraction for those considering between universal life and whole life.
During periods of high interest rates, universal life insurance premium is generally lower than whole life insurance premiums, often for the same amount of coverage. The reason is because whole life insurance premiums are partly determined by the interest rate at the time and is fixed.
Another key difference is how the interest is paid. While the interest paid on universal life insurance is often adjusted monthly, interest on a whole life insurance policy is normally adjusted annually. This could mean that during periods of rising interest rates, universal life insurance policy holders may see their cash values increase at a rapid rate compared to those in whole life insurance policies.
If you like having more flexibility in terms of premiums paid and the option to change the death benefit amount, universal life insurance is probably more appropriate for you.
On the other hand, if you prefer having a set death benefit and level premiums for the duration of your life, then a whole life insurance policy is more appropriate.
If you've ever taken out a mortgage, you could think about a universal life insurance policy more like an adjustable rate mortgage. You get to pay a lower amount for a fixed portion of time, but will have to pay attention to interest rates, especially once the fixed rate resets.
A 30-year fixed rate mortgage may be more similar to a while life insurance policy. The interest rate may be higher, but you just set it and never have to think about it again because your payment is fixed forever unless you refinance.
Universal Life Insurance Cost And Growth Chart
Below is an example of a universal life insurance cost and growth chart for a 42-year-old male in the highest preferred plus rating. The level death benefit is for $500,000.
The monthly premium is $830 in order to pay for the $500,000 death benefit and build the cash value. $830 doesn't sound cheap compared to a term life insurance policy. However, remember, you're building a tax-advantageous cash value that will grow over time.
In this example, the minimum guaranteed interest rate is 2% and the current interest rate is 4.25%, but it can go higher during different economic times.
Please realize there are many different life insurance options to choose from. Universal life insurance is a good option, but it's also good to learn about all your options.
Finding The Right Policy for You
A universal life insurance policy is a good idea if you want to have life insurance for your entire life instead of just a fixed term. Life is truly unpredictable.
Who would have thought someone like Kobe Bryant would have died in a helicopter crash in his early 40s? Who would have that there would be a coronavirus pandemic that would shut down global economies for months?
A universal life insurance policy provides flexibility, permanent life insurance, and the ability to build wealth through its cash value tax-efficiently.
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Life insurance is an act of love. Please get life insurance to protect your family.
