Universal life insurance is a form of permanent life insurance. Unlike term life insurance with a contractual expiration date, permanent life insurance provides lifetime coverage (the expiration date of the policy is your personal expiration date, so to speak). As long as you pay your premiums and your account has sufficient funds to cover the cost of insurance, you do not have to worry about cancellations or renewals. Because the death benefits are exempt from federal taxes, these policies are often used by surviving spouses to cover income needs, post-death expenses, and any applicable estate taxes.
Permanent life policies have a face value similar to a term policy, but they also contain a cash value component. The premium you pay is split between the actual cost of the insurance and a cash account that can be directed in different ways depending on the policy. This account can be deposited or invested by the insurance company to provide tax-deferred interest earnings.
With a term policy, your premiums are predictable and regular, but when the term is up and you need to extend or renew your coverage, your risk factors are likely to be re-evaluated (and will probably be higher, as you have aged). Your premiums may increase significantly and if you are in poor health, it may be difficult for you to acquire insurance at all. On the other hand, a permanent life policy has already taken into account your actuarial risk factors and expected remaining life span. This type of permanent life coverage is preferable if you expect your costs of renewing term insurance later in life will be greater than the costs of a permanent life policy.
The major categories of permanent life insurance are whole life and universal life. Whole life policies feature consistent premiums, a constant interest rate on the cash value portion, and fixed death benefits. Universal life policies offer greater flexibility in management of cash assets.
Policies will vary by insurer, but generally, a universal life policy provides several options to help you through cash-poor times. Since they already have collateral, insurers will usually allow you to borrow against the cash value of your policy at reasonable rates without restrictions for use, credit-check concerns, or any effect on your credit rating.
You can also alter the premium amounts, or have your premium payments paid by the cash value portion of your policy (check your specific policy for any restrictions on this). There are three typical premium options:
- Single premium: A single, very large, initial payment — not very popular.
- Fixed premium: Features periodic premium payments with a no-lapse guarantee.
- Flexible premium: Features the ability to change premiums periodically within boundaries.
Flexibility in death benefits is another advantage of universal life insurance. You can change the death benefit amount, and have your beneficiary receive the face value or the face value plus some or all of the cash value.
Variable universal life policies offer options for investing the cash value portion in financial vehicles like mutual funds to provide potentially higher earnings. Of course, these can also provide potentially lower earnings. It is possible for your cash value to drop to zero and risk policy cancellation (unless you have a guaranteed universal life policy, where your policy remains valid even if the cash value drops to zero). The bottom line: do not miss a payment and monitor your cash value.
If you are more comfortable with managing your own funds and think you can beat the return on the insurance policy's investment strategy, a universal policy may not be ideal for you. In any case, before deciding which form of insurance is best for you, carefully consider tax implications and fees, and consult with an experienced professional.