A Guide to Universal Life Insurance

Universal life insurance pays variable interest, so it could earn more than whole life policies.

Andrew MarderMay 27, 2020

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For buyers who need life insurance that lasts until death, builds cash value and offers flexibility in payments and benefits, universal life could be the right choice. Unlike term life, universal life insurance covers you for your entire life. Unlike whole life, you’ll earn market-based interest on your account balance.

That increase in control compared with whole life insurance comes with more responsibility and increased variability. If that doesn’t sound like a burden to you, universal life can be a good choice.

What universal life insurance is

Universal life insurance is a type of permanent insurance, covering you until death just like a whole life policy. Universal life policies have a variable interest component that can change your premium payments for better or worse, depending on the market rates for other investments such as Treasury bills. Universal policies also have the option to change death benefits, the amount paid to your beneficiaries when you die.

Universal life is called "universal" because it’s meant to be a product for anyone with any need. Big payment, small payments, changing coverage — you name it — universal policies are supposed to allow for it.

The main features of universal life insurance are:

  • Your policy has a cash-value component, which grows tax-free and you can borrow against when it has accumulated enough value.

  • Your cash-value account earns interest at the market rate.

  • You have the option to increase — if you qualify — or decrease your death benefit. This can be because you have a change in coverage need or because you want to change your premiums.

  • You can pay more than the recommended premium to increase the value in your cash account.

  • You can pay less than the recommended premium and draw from your account to cover the shortage. In some instances, you may be able to halt payments.

  • Your money is exposed to the ups and downs of benchmark interest rates, mainly those set by the Federal Reserve.

Universal life policies have become increasingly popular since the 2008 financial crisis, when sales of a subset of universal life — indexed universal life — started a steady climb. Non-variable universal life policies now make up over a third of annual sales by premiums, making them the most popular type of life insurance available to individuals.

How universal life insurance works

Permanent — also called "cash value" —  life policies have two main parts. The first is the insurance. This is the part that pays out when you die and that an insurer will charge you "cost of insurance" (COI). As you get older, this portion becomes more expensive.

The second part is a cash-value account. When you make a premium payment, the insurance company will take out the COI and administrative fees and put the rest into your cash-value account.

In a universal life policy, this cash value is invested in the insurance company’s general account, earning you interest based on that account’s performance.

What’s in that account? Nothing very interesting — mainly bonds with some stocks, mortgages and so on mixed in. Universal life insurance rates often have minimum guaranteed rates, which depend on the insurer and the current interest rate environment.

Benefits of universal life insurance

Universal life’s major benefits are control and market rates.

Control comes in the form of flexible premiums and coverage:

  • Universal policies allow you to change the size and frequency of your payments. You can overpay — within regulatory limits — when you have extra money available and underpay if times are lean. Underpaying may result in a decrease in coverage, so check with a financial advisor before making any changes.

  • You can also change your death benefit with a universal life policy. If you need more coverage and can pass an updated medical examination, you can easily add to your death benefit. If you want to decrease your benefit, you can simply fill out a form to do so.

The money in your cash-value account will earn interest based on the insurer’s general account investments at the market rate. This means it’s possible to earn more than you would in a whole life policy with a flat, guaranteed rate.

Disadvantages of universal life

Universal life’s benefits are also its disadvantages.

  • Control comes with increased responsibility. You can miss payments, underpay and underfund your account. If you don’t pay attention to the value of your account, you could wind up needing to make a series of large payments to maintain the coverage you signed up for.

  • Market rates bring volatility. When interest rates are rising, universal life insurance looks like a great product. Interest rates have been below 3% for over a decade, and the more rates shift from the time you buy a policy, the less accurate your original payment and account value projections will be.

How much universal life insurance costs

Policy value

Whole life

Universal life

Male, age 30

$250,000

$1,829

$1,186

$500,000

$3,600

$2,345

$1 million

$7,123

$4,103

Female, age 30

$250,000

$1,626

$1,023

$500,000

$3,195

$2,014

$1 million

$6,313

$3,563

Male, age 40

$250,000

$2,735

$1,643

$500,000

$5,412

$3,263

$1 million

$10,747

$5,962

Female, age 40

$250,000

$2,441

$1,450

$500,000

$4,825

$2,840

$1 million

$9,573

$5,135

Male, age 50

$250,000

$4,244

$2,481

$500,000

$8,432

$4,925

$1 million

$16,787

$9,105

Female, age 50

$250,000

$3,790

$2,165

$500,000

$7,522

$4,260

$1 million

$14,967

$8,090

Male, age 60

$250,000

$6,835

$4,136

$500,000

$13,613

$8,225

$1 million

$27,150

$15,434

Female, age 60

$250,000

$5,998

$3,609

$500,000

$11,940

$7,143

$1 million

$23,683

$13,460

Source for all rates: Quotacy. Average rates are per year for a policy from the top three carriers for nonsmokers.

Universal life insurance vs. other life insurance options

Term life

Whole life

Universal life

Indexed universal life

Variable universal life

Policy duration

Any length

Permanent

Permanent

Permanent

Permanent

Cash value interest calculation

No cash account

Fixed interest rate, non-guaranteed dividends

Bond interest rates

Stock indexes

Stocks or other investments

Flexible premiums

No

No

Yes

Yes

Yes

Cash account value can decline

N/A

No

Yes, if rates are low and fees high

Yes, if index growth is low and fees are high

Yes, if stocks perform poorly

Flexible death benefits

No

No

Yes

Yes

Yes

Out of pocket cost

$

$$$

$$-$$$$

$$-$$$$

$$-$$$$

Term Life

Whole Life

Universal Life

Indexed Universal Life

Variable Universal Life

Policy duration

Any length

Permanent

Permanent

Permanent

Permanent

Cash value interest calculation

No cash account

Fixed interest rate, non-guaranteed dividends

Bond interest rates

Stock indexes

Stocks or other investments

Flexible premiums

No

No

Yes

Yes

Yes

Cash account value can decline

N/A

No

Yes, if rates are low and fees high

Yes, if index growth is low and fees are high

Yes, if stocks perform poorly

Flexible death benefits

No

No

Yes

Yes

Yes

Out of pocket cost

$

$$$

$$-$$$$

$$-$$$$

$$-$$$$

Universal life insurance vs. whole life

Whole life policies offer permanent coverage at a fixed premium and fixed death benefit. At the beginning of the policy’s life, you’re overpaying for your COI. At the end of the policy, you’re underpaying. The whole life policy spreads that cost out sort of like a mortgage does.

Universal life doesn’t have the same feature. You need to pay enough to cover your COI, but you don’t have to pay excess.

A universal life cash-value account is usually funded more heavily in the first few years of a policy. That builds the account value up, starts the interest-earning process and gives you a buffer in later years. Then, you should be able to decrease payments as time goes on.

Universal life insurance death benefit options

One of the biggest decisions you'll make in a universal life policy is how your death benefit is paid. There are two choices:

  • Have the death benefit remain the same through the life of the policy. For instance, if you sign up for $100,000, build up some cash value — let’s say $60,000 — to help pay premiums, then you die, your beneficiaries get $100,000.

  • Add the value of your cash-value account to the death benefit. So, in the previous example, your beneficiaries would get $160,000 — the death benefit plus the cash value.

Since using the second option means your cash account the insurer would normally hold onto after death is now passed onto beneficiaries, it’s the more expensive option.

Universal life policy riders

There are several riders your insurance company may offer for a universal life policy. Life insurance policy riders are additions to your contract that make the policy work in a new way. They might add features or guarantees, but they’re all optional and come with a fee.

  • No lapse guarantee. Any life insurance policy exposed to the market may not work out as advertised. You might end up owing more to your policy than you ever imagined. No lapse guarantees make it so that, as long as you pay a minimum premium, your death benefit will remain in place, even as your account value drops.

  • Waiver of premium. This allows you to skip payments if you become disabled. It’s basically insurance for your insurance payments.

  • Accelerated death benefit allows you to access some or all of your death benefit ahead of time if you suffer a major medical setback — heart attack, stroke, etc. — or if you’re diagnosed with a terminal illness. Different insurance companies treat each condition separately, so check to see which illnesses will be covered and what your benefit may be.

  • Family riders. Child and spouse riders allow you to add term life coverage for additional members of your family under your universal life policy.

  • Accidental death. These riders increase the payout from your policy if you die in, or as a result of, an accident.

  • Guaranteed insurability, which allows you to increase the death benefit of your policy at specific life stages or policy anniversaries, even without an exam or health questionnaire. For example, you could increase your death benefit when your child was born, even if you developed a medical condition.

How to find the best universal life company

Universal life policies are complex, so to find the right company, you’ll need to look for a few things.

First, you'll want a life insurance provider that is financially strong so you'll know your cash-value account is safe and your beneficiaries will receive a payout when you die. You can find financial strength ratings for most companies from A.M. Best or Standard and Poor's, but you may need a free login to check. A solid life insurance company will have a letter grade of A- or better from A.M. Best.

Second, you should find a company that offers the policy options you’re looking for — the riders above may not be available from each company. Universal life policies can be sold with different guaranteed minimum interest rates and various fee structures.

Finally, you should consult with a financial advisor — fee-only financial planners can help you here — to better understand how the company’s products differ and which one is right for your long-term goals.

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