When the main objective is taking care of your loved ones after you’re gone, it pays to spend time figuring out how to care for them. That’s why you should familiarize yourself with the full slate of possibilities. For those looking for flexible premiums and the opportunity to accumulate wealth on a tax-deferred basis, universal life insurance can be a smart option. You may even be able to benefit from it during your lifetime. But due to their complexity and cost, these policies aren’t suited to everyone, so take the time to understand how they work.
What is universal life insurance?
Universal life insurance is a form of permanent life insurance, meaning it offers lifelong coverage as long as you keep making your payments. Unlike term life insurance, a universal policy does not expire at a certain age, nor after a predetermined number of years.
One of the most important features of universal life insurance is the inclusion of an investment account, allowing policyholders to invest and accumulate wealth on a tax-deferred basis. Think of universal life insurance as a policy and investment account in one: a portion of your premiums is used to cover the cost of your insurance, and the remaining funds are yours to invest.
Here’s how it works: You make regular payments into your policy’s investment account. Each month, the insurer deducts your insurance premiums and policy fees from the account. Depending on the investment you choose, the rate of return on the leftover funds can be guaranteed or not. The interest earned on your investments is not taxed (up to a certain amount outlined by the government) as long as the money stays in the account.
Depending on your policy, you may be able to make withdrawals or take out an interest-bearing loan against the cash value of your policy. The cash value refers to the cash amount that accumulates within your policy, and it is distinct from the death benefit. If you cancel a permanent life insurance policy, you get its cash value. However, in most cases, the cash value does not typically pass to your beneficiaries—only the death benefit does.
The benefits of universal life insurance
Universal life insurance is more complex than other forms of life insurance. The premiums also tend to be higher than with term life insurance; they are generally more comparable to those for whole life insurance, but can fluctuate—unlike whole life premiums. And depending on how the investment portion of the policy performs, the cash value is not guaranteed. For these reasons, a universal insurance plan is not a good fit for everyone.
However, there are benefits for those prepared to spend the time to understand the nuances of universal life insurance:
- Unlike with other life insurance policies, the policy holder can decide how to invest the money in their account.
- The premiums are also more flexible. You can pay more and invest the balance, or you can choose to pay less or even skip payments entirely, as long as you already have enough in the account to cover the premiums.
- You can borrow or withdraw funds from your policy account; however, each policy may have different withdrawal and loan requirements.
- The policy’s cash value can change: If your investments do well, you could end up with a larger cash value. Of course, the flip side is also true: You can also lose money if your investments perform poorly.
Universal life insurance vs whole life insurance
Even if you know you want permanent life insurance, you’ll still have to pick between universal life insurance and whole life insurance. Here are some of the key differences: