Are you considering a universal life (UL) insurance policy, but want to know more about how it works?
Universal life policies are a great coverage option that also allows you to plan for retirement if utilized properly. Although the various forms can be confusing, we’ve broken down everything you need to know about this type of policy in our comprehensive guide.
Learn what a universal life insurance policy is, how it works, and everything else you’ll need to determine if this form of policy is right for you.
What is Universal Life Insurance?
Universal life insurance policies are a type of permanent life insurance that covers a policyholder throughout their entire life as long as premiums are paid. Unlike other whole life policies, universal life features flexible premiums that allow the policyholder to raise or lower premiums within limits. Any extra premium payments go into a savings component that builds cash value. When the policyholder passes away, the policy’s death benefit is paid to beneficiaries.
How Does Universal Life Insurance Work?
Universal life insurance policies work by splitting up the money you pay towards monthly premiums into two flexible parts.
- Cost of Insurance (COI): The COI portion of your premium is the minimum amount needed to maintain coverage and provide a death benefit. This increases as you get older, meaning your premiums will get more expensive.
- Cash Value: This portion of the premium is used for investments and is optional. You can choose to not pay it and have cheaper premiums, or contribute money towards the cash value which will grow over time.
Types of Universal Life Insurance
Just as the premiums are flexible for universal life insurance, consumers also have several options when choosing which type of policy is best suited for their needs. The four types of universal life insurance include:
1. Traditional Universal Life
Traditional universal life insurance policies provide people with flexibility in the amount or frequency of their premium payments over the life of the policy. It’s designed so you can pay higher premiums when you’re earning more, or cut back in times of financial stress (in which you use the cash value of the policy to cover monthly payments).
This policy can be great if utilized properly, but many policyholders don’t pay beyond the minimum premium to maintain the policy which leads to a very small cash value. Traditional universal life insurance is also non-guaranteed, meaning your premium costs are not guaranteed to stay the same throughout your life. This is important, because premium costs rise as you age and you risk lapsing or needing to surrender the policy if you lack sufficient funds from the savings element.
2. Guaranteed Universal Life
Guaranteed universal life insurance policies are similar to their traditional counterparts, except the premiums are guaranteed to stay the same throughout the life of the policy. Fixed premiums are attractive to many, as it means you don’t have to worry about skyrocketing payments as you age. These policies also feature a “no-lapse” element that guarantees coverage for the rest of your life as long as you pay your monthly premium.
The downside of a guaranteed universal life insurance policy is that it’s not designed to build significant cash value. Although there is an investment component, the growth is typically minimal. The main purpose of this policy is to provide fixed premiums throughout your life and a guaranteed death benefit to beneficiaries upon your passing.
3. Indexed Universal Life
Indexed universal life policies can be guaranteed or non-guaranteed, but what makes them unique is how they tie into the stock market. These policies are linked to a stock market index, such as the S&P 500 or Nasdaq, and the money you earn from investing depends on the performance of the market. For example, you may see a large cash return if your index goes up, but it could just as easily lose value with a decline which would also cause your premiums to rise.
4. Variable Universal Life
This policy is similar to a non-guaranteed indexed universal life insurance policy, but instead of just tying your policy to an index — you can get more hands-on and invest the money directly. Specifically, you can invest the cash value into various mutual funds of your choice. These mutual funds are large sums of money managed by a team of experienced professionals who invest the money into several companies. This is a great option for people with finance experience looking to maximize the cash value of their policy, but it can be much riskier than indexed universal life insurance and comes with significant fees when you decide to cash out.
Pros and Cons of Universal Life Insurance
As you probably realize by now, each type of universal life insurance policy seems to have its own pros and cons. However, there are a couple of commonalities that seem consistent regardless of the policy type.
Pros of Universal Life Insurance
- Lifelong coverage: Universal life insurance offers you lifelong coverage as long as you are able to pay your premiums. Furthermore, many people like not having to deal with the pains of switching providers every few years and this type of policy can pay for itself later in life if you invest enough money early on.
- Flexible premiums: This type of policy gives you much more financial freedom in how you pay premiums and invest the cash value of your policy compared to other alternatives. You can opt to pay an excess when you have cash to spare, or cut back in times of financial need.
- Investment options: There are several ways you can invest your money with this type of policy, which enables you to build cash value to cover living expenses during retirement. Whether you choose to leave the investment portion of your policy to grow on its own or get more hands-on with your investment strategy, this feature offers a range of options.
Cons of Universal Life Insurance
- Confusing terminology: The fine print of all insurance policies can be confusing, but the combination of insurance and finance terminology makes it especially true for this type of policy.
- Cash value lost upon policyholder’s death: In general, the cash value you’ve accumulated will go to the insurance company upon the policyholder’s death. To combat this, you may be able to increase the cash value is it builds over time.
- Uncertain risk factors: Regardless of whether you have a guaranteed or non-guaranteed policy, universal life insurance can be risky as there are several factors subject to change. Failure to save excess funds puts guaranteed policyholders at risk later on, as these policies don’t generate significant cash value over their lifespan. On the other hand, non-guaranteed policies have premiums that can potentially skyrocket later in life and the return potential can be risky depending on how your investments turn out.
- Taxable Withdraws: If you withdraw money from the cash value associated with your UL policy, you’ll have to pay taxes on any profits that exceed the amount you’ve contributed.
Don’t Risk Coming up Short in Retirement, Use a Life Settlement to Cash out Early
Universal life insurance policies can be a great way to save for retirement if utilized properly, but between the confusing terminology, high fees, and uncertain risk factors — you may be better off selling your policy for a lump cash sum through a life settlement.
Rather than continue paying premiums and fees with each withdrawal, you can sell your life insurance policy for a lump sum of cash that can be used as you see fit during retirement. By doing this, you’ll no longer have to pay monthly premiums and you won’t have to worry about your retirement savings declining due to external market factors that can affect your investment. Get in touch with Harbor Life Settlements today to determine your eligibility and get a FREE cash estimate on the value of your life insurance policy.