Understand Universal Life Insurance
If you’re in the market for life insurance, there are plenty of options available. And if you’re looking for a policy that offers lifelong coverage, one option worth considering is universal life insurance.
With universal life insurance, you can receive lifelong coverage. The life insurance payout, called a death benefit, is paid to your beneficiaries tax-free. Some universal life policies also build cash value, with gains growing tax-free. And there may be flexibility to adjust your premium payments and death benefit, depending on the policy.
In this article, we’ll walk through what you need to know about universal life insurance.
How Does Universal Life Insurance Work?
Universal life insurance is a type of permanent life insurance. It can cover you for the duration of your life, as long as the premiums are paid. Some forms of universal life insurance also offer a cash value component.
The cash value can build up investment gains (and sometimes get hit with losses, depending on the policy type).
You can take money out of cash value via a withdrawal or loan. The insurance company will reduce the payout to your beneficiaries by the amount of any withdrawals or outstanding loans if you pass away. But for some buyers, accessing cash value is more important than a full payout to beneficiaries later on.
Like other life insurance policies, including whole life insurance and term life insurance, you can add a variety of riders to universal life policies. Riders are a way of adding extra coverage or features, usually at extra cost.
One example is an accelerated death benefit rider. Often included with policies at no additional cost, it lets you take money from your own death benefit if you are diagnosed with a terminal illness. (Rules for when you can tap into the money vary by company.) Other common options are chronic illness riders and long-term care riders, which both let you take money from the death benefit when you have certain health conditions.
Types of Universal Life Insurance
There are a few common types of universal life insurance policies and it’s crucial to understand what you’re buying. Their costs and features are quite different.
Caveat Might lapse if you miss even one payment Participation rates and caps can limit your cash value’s upside in a good market You usually need to manage your sub-accounts and could lose your cash value if your investments drop
Guaranteed Universal Life Insurance
A guaranteed universal life (GUL) insurance policy offers a death benefit and premium payments that will not change over time. You select an age at which the policy ends (such as age 90, 95, 100, 105, 110, or 121). Choosing a higher age will increase the premium.
Guaranteed universal life insurance generally has little or no cash value. Because of this it’s the cheapest kind of universal life insurance you can buy. You’re paying for the lifelong coverage.
GUL is sometimes called “no lapse guarantee universal life insurance.” This is to address recent problems where traditional, non-guaranteed universal life insurance policies lapsed because the cash value couldn’t cover the policy’s expenses and the cost of insurance. Some policyholders who wanted to keep their insurance in force had to suddenly pay much larger premiums that they never expected.
These newer no-lapse policies promise to stay in force. But there’s a catch: If you make a late payment or miss one, the policy will likely terminate. Since there’s usually no cash value, there won’t be any money to take away. The insurance company will keep the premiums you paid.
Unlike other types of universal life insurance, a GUL policy doesn’t offer flexibility with the premium payments or death benefit amount. However, it can be a good choice for someone looking primarily for lifelong coverage and who cares less about the “investment” component of cash value.
Average Costs of Guaranteed Universal Life Insurance
Averages below are examples of annual rates for a $1 million GUL policy for healthy non-smokers, guaranteed to age 100 or older.
Age Male Female
30 $3,943 $3,539
35 $4,741 $4,246
40 $5,956 $5,262
45 $7,026 $6,128
50 $9,035 $7,891
55 $11,368 $9,769
60 $14,647 $12,660
Averages are based on the five cheapest quotes we found online for a $1 million guaranteed universal life policy, for healthy non-smokers of average height and weight.
Indexed Universal Life Insurance
Indexed universal life insurance (IUL) offers lifelong coverage and may have some flexibility with the death benefit and premiums. You may be able to adjust your death benefit and payments within certain limits if your needs or budget change.
There’s a cash value component in IUL that’s often tied to a stock market index such as the Nasdaq-100, S&P 500 or a combination of indexes. You might also have the option of a fixed-interest investment.
When you pay premiums, part of the money goes to (potentially high) policy fees and charges, and the remaining goes into cash value.
It’s important to understand the boundaries of your potential investment gains. Indexed universal life insurance policies have participation rates and caps. The participation rate is a portion of the index gains that your cash value will actually receive. For instance, if your index went up 10%, and you have a participation rate of 50%, you’ll gain 5% upside. Additionally, there’s usually a cap, which is the maximum percentage you can gain no matter how well the index performs.
If your index plummets, you’ll still have a “floor” that guarantees a minimum return rate, which can be 0%. Still, it’s possible to lose all your cash value if policy charges and expenses eat through your money.
Owning an IUL policy doesn’t mean that your money is actually invested in the index. In reality insurers still mainly invest in bonds. So the index is just a barometer to calculate cash value gains and losses. And the calculation of your gains won’t include any dividends that you might otherwise pocket if you invested directly.
Variable Universal Life Insurance
Variable universal life (VUL) insurance also allows you to vary premium payments and the death benefit amount, within limits. You’ll generally need to actively manage this kind of policy because you’ll select sub-accounts for your cash value investments. You may also be able to choose a fixed interest rate option for cash value.
With variable universal life insurance you have a potential for good returns on your cash value (if you’ve invested wisely) and you have a certain level of control over your investments.
But your cash value could also tank if the investment choices bottom out. Also, these policies tend to have higher fees than other universal life policies and are often a lot more complex.
Other Types of Universal Life Insurance
Here are other varieties of UL you might come across:
Cash accumulation UL: A universal life insurance policy that’s specifically designed to build up cash value quickly early on.
Current assumption UL: A traditional UL policy designed to offer coverage at a low cost because the death benefit is not guaranteed. Your cash value grows based on the “crediting rate” offered by the insurer, which can change the rate. You may be able to change the timing or amounts of your payments, or modify the death benefit, but you need to make sure that your policy account contains enough money to cover the policy’s fees, the cost of insurance, and any loans or withdrawals you’ve taken. If it doesn’t, the policy could lapse. These policies have been under scrutiny recently, after some policyholders got hit with large, unexpected premium increases when their cash value fell below the minimum requirements.
How to Take Money from Cash Value
When it comes to taking the cash value from a policy, you generally have a few options. Make sure you understand the policy’s rules for taking out cash value and all of the financial implications that come with that decision.
Withdraw funds from your cash value: You could make a tax-free withdrawal from your policy. However, if you withdraw more cash value than the portion funded by your premium payments, the investment gains you take are taxed as income. Also, taking out cash value will reduce your death benefit and your beneficiaries will receive less.
Borrow against your policy: Typically you can borrow tax-free from the cash value of your policy. If you die before the loan and interest are repaid, the outstanding balance will be subtracted from your death benefit.
Surrender the policy: If you decide you no longer want or need life insurance, you can contact the insurer to surrender the policy. You’ll receive the cash value minus any surrender charge.
Medical Exams for Universal Life Insurance
Many sellers of universal life insurance use “full underwriting,” meaning they take time to fully examine your application, verify information, and require that you do a life insurance medical exam. The medical exam usually includes height, weight, blood pressure, and blood and urine samples. It’s generally done by a paramedical professional hired by the insurance company, and can be done at home.
There’s a wide variety of data about you available to insurers, who can use it in pricing policies. This includes data on consumer credit, your prescription drug history, your answers on past individual health and life applications, and your motor vehicle record. It’s also common for insurers to request your medical records.
Who Should Consider Universal Life Insurance?
If you want life insurance coverage that lasts the duration of your life, you might consider a universal life insurance policy. For example, universal life insurance can fund a trust to take care of a special needs child or other dependents after you’re gone.
You might also consider a universal life insurance policy if you have big long-term savings goals and need both an investment vehicle and life insurance, but only after you’ve maximized other savings options such as retirement plans.
Alternatives to Universal Life Insurance
Universal life isn’t the right choice for everyone’s situation. Other types of life insurance might be better, depending on the policy length and guarantees you want.
Whole Life Insurance: Lots of Guarantees at a High Cost
Like universal life insurance, whole life insurance gives you coverage for the duration of your life. It also includes a cash value component. The biggest difference between whole life insurance and universal life insurance is the cost: Whole life insurance is generally the most expensive way to buy permanent life insurance because of the guarantees within the policy: premiums are guaranteed not to change, the death benefit is guaranteed and cash value has a minimum guaranteed rate of return.
Also, indexed and variable universal life can give you flexibility with payments and the death benefit amount after you buy the policy.
Whole life, on the other hand, guarantees that your premiums, the cash value guaranteed rate of return and the death benefit won’t change. Whole life insurance is suitable for someone who likes predictability and is willing to pay for it.
In addition, many whole life insurance policies pay dividends. These are like annual bonuses paid by mutual insurance companies to customers, although not guaranteed. You can use dividends to pay premiums, add it to your cash value or simply take the money.
Term Life Insurance: Cheapest Option
Term life insurance is generally available for 5, 10, 15, 20, 25 or 30 years. It doesn’t have a cash value component and you could outlive the policy. But it’s the cheapest way to buy life insurance. For example, you could buy a 20-year policy to cover young children’s growing years and college time. Or a 30-year policy when you buy a house and take out a mortgage.
If you outlive the term life policy it expires. There’s no cash value to take away. That’s why it’s good to match your term life policy as best you can to the length of time you’ll need coverage.
*Indexed Universal Life Insurance is an insurance contract that, depending on the contract, may offer a guaranteed annual interest rate and some participation growth, if any, of a stock market index. Such contracts have substantial variation in terms, costs of guarantees and features and may cap participation or returns in significant ways. Any guarantees offered are backed by the financial strength of the insurance company, not an outside entity. Investors are cautioned to carefully review an indexed universal life insurance for its features, costs, risks, and how the variables are calculated.
Author: Ashley Chorpenning
Source: © 2020 Forbes Media LLC
Retrieved from: Forbes.com
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