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Don’t guess if you should enroll in a universal life policy. HealthMarkets can help you explore the universal life insurance pros and cons. It’s like getting a sneak peek before you buy so you can decide if it’s the right type of life insurance for you. Read on to learn the ups and downs of how universal life premium payments, cash value, and death benefits work.
Overview of Universal Life
Universal life is an adjustable type of permanent life insurance that allows you to make changes to two main parts of the policy: the premium and the death benefit, which in turn affects the policy’s cash value. Universal life combines the pure insurance elements of term life with the savings account features of whole life insurance. Below are some of the overall pros and cons of universal life insurance.
- Designed to offer more flexibility than whole life
- Doesn’t have the guaranteed level premium that’s available with whole life
- Cash value grows at a variable interest rate, which could yield higher returns
- Variable rates also mean that the interest on the cash value could be low
- More opportunity to increase the policy’s cash value
- A policy usually needs to have a positive cash value to remain active
Pros and Cons of Universal Life Adjustable Premiums
One of the most attractive features of universal life insurance is the ability to choose when and how much premium you pay, as long as payments meet the minimum amount required to keep the policy active and the IRS life insurance guidelines on the maximum amount of excess premium payments you can make. The option to adjust your premium payment is available once your policy has built up enough cash value and after you’ve made your first regular payment. But with this flexibility also comes some drawbacks. Let’s go over universal life insurance pros and cons when it comes to changing how you pay premiums.
Pros: Unlike other types of permanent life policies, universal life can adjust to fit your financial needs when your cash flow is up or when your budget is tight. You may be able to:
- Pay higher premiums more frequently than required
- Pay less premiums less often or even skip payments
- Pay premiums out-of-pocket or use the cash value to pay premiums
Cons: Paying the minimum premium, less than the target premium, or skipping payments will negatively affect the policy’s cash value. Doing these things may:
- Cause the policy to not build cash value — paying the minimum premium only covers the cost of the policy; it doesn’t provide any excess premium to build cash value.
- Slow down or lower the policy’s cash value build up — the insurance company sets a “target” premium that it estimates is enough to cover the cost of coverage while also building cash value. Paying less than the target means less money will contribute to the cash value portion of the policy. When you skip a payment, the cash value is used to cover the cost of providing you with insurance. If you do this a number of times, this will lower the cash value.
- Make the policy lapse — Only using the cash value to cover the premium will eventually make the policy run out of cash value, at which time the policy may lapse and your coverage may end.*
Universal Life Policy Pros Cons: Accessing the Cash Value
A universal life policy accumulates cash value from a portion of your premium payments and the variable interest rate at which the policy grows. So when you make higher premium payments, more money goes toward the policy’s cash value. If the policy’s interest rate grows higher than expected, then the cash value builds more quickly. But there are some advantages and disadvantages to accessing the cash value in your policy.
Pros: Unlike a bank loan where you have to qualify based on your credit, you don’t need to qualify to take a loan out on a life insurance policy. This is standard with all policies that build cash value. You also don’t need to repay the loan. Another advantage is you usually don’t have to pay income tax on the loan. If you want to withdraw cash without it surrendering or canceling the policy, you can do so through a partial withdrawal. Partial cash withdrawals are usually tax-free.
Cons: You can only borrow up to the amount of cash value in the policy. And the money you borrow doesn’t actually come from your cash value — the money comes from the insurance company and your cash value is used as collateral. Even though you don’t have to repay the loan, it’s not free money. You are charged interest on the loan. If you don’t at least pay the interest, the interest will grow larger and reduce your cash value, which could lead to a policy lapse. If the loan is not paid off when you die, the loan amount plus interest will be subtracted from the death benefit your beneficiary receives.
Withdrawing money from the actual cash value usually cannot be done within the first few years of the policy’s life. Some policies let you do a permanent withdrawal of up to 90% of the cash value, but this reduces your death benefit permanently. Withdrawals that reduce your death benefit are usually subject to income taxes.
Pros and Cons of Universal Life Insurance Death Benefit
Another feature of having an adjustable life insurance policy is that you can make changes to the death benefit by decreasing or increasing the amount. Depending on your circumstances, this can be either an advantage or a disadvantage.
Decreasing a Universal Life Policy’s Death Benefit
Pros: You have the flexibility of lowering your death benefit, usually at any time, to suit your life and financial needs. For instance, if the main purpose of your death benefit was to replace your income while your children were young, then you could choose to reduce the death benefit once they become working adults. In the same respect, lowering the policy’s death benefit can be advantageous because this generally results in paying lower premiums, which would be helpful in situations like earning less income.
Cons: Reducing the death benefit also means that your beneficiary will get less money upon your death than what you initially planned for when you got the policy. Although you may need to lower the amount, the catch is if you were to die and your family’s need for financial support is great, the payout from the policy might not be enough to sustain your household for the years when they need the most income replacement.
Increasing a Universal Life Policy’s Death Benefit
Pros: A larger death benefit of course means your beneficiary will get a higher payout upon your death. With more money, your family could survive financially for a longer time or pay off larger debts.
Cons: Increasing your death benefit usually means taking a medical exam because you have to go through the insurance company’s underwriting requirements again. This will likely increase your premium rate because the policy’s face value will be larger.
How Universal Life Option A versus Option B Death Benefit Works
Universal life insurance pros and cons also apply to how the death benefit works. You can choose how the death benefit will be paid out by selecting either Option A or Option B. Option A provides a level death benefit for the life of the policy, while Option B provides an increasing death benefit that’s equal to the policy’s face value.
Option A: Level Death Benefit
Pros: The main advantage is that you pay less in premiums for the same death benefit than you would under option B. This is because as the policy’s cash value grows, you pay for less pure insurance, which reduces your risk to the insurance company. Instead of paying premiums based on the policy’s death benefit amount, you pay premiums for the lesser pure insurance amount. So if your death benefit is $500,000 and your cash value is $100,000 for example, the pure insurance you pay for is $400,000. With paying for just the pure insurance, the policy acts similar to term life insurance.
Cons: With the advantage of having lower premiums because you only pay for the pure insurance comes the disadvantage of your beneficiary only receiving a payout that’s equal to the face value. So if the policy’s death benefit is $500,000, this is equivalent to the face value and would be the amount paid out (minus any outstanding loans and interest). If you wanted to increase the death benefit, you would have to pay excess premiums — more than what’s required to keep the policy in force.
Option B: Increasing Death Benefit
Pros: This option gives your beneficiary a greater financial advantage because he or she would receive both the face value and the cash value amount. Using the $500,000 face value and $100,000 cash value example, your beneficiary would get a total payout of $600,000, if there aren’t any outstanding loans and interest.
Cons: The downside of this option is that you pay premiums on the full face value for the life of the policy regardless of how much cash value the policy has. So as you increase the face value/death benefit over time, the premium would also increase to keep up with the larger amount of coverage.
Universal Life Insurance Types: Pros and Cons
There are generally 3 types of universal life insurance with each increasing in the level of risk. Starting with the least risky, these are: fixed universal life, fixed indexed universal life, and variable universal life.
Fixed Universal Life Pros and Cons
Pros: This is the least risky of the 3 because the cash value accumulates interest based on the insurance company’s overall investment accounts, which are usually tied to bonds that are relatively safe. This type of policy typically has a guaranteed fixed interest rate that is not subject to changes in the market, which provides more stable growth of the cash value.
Cons: Because the insurance company’s investment portfolio grows according to the performance of these safer bonds, the cash value earns a lower return.
Fixed Indexed Universal Life Insurance Pros and Cons: How it Works
A fixed indexed universal life (FIUL) policy builds cash value based on the stock market index it’s attached to. You can choose from a variety of indexes, such as the NASDAQ-100 and S&P 500. Like other permanent life policies, you can use the tax-deferred cash value in your life insurance for retirement planning.
Pros: With an FIUL policy, you can get the following advantages.
- The option to choose how much of your cash value to put in an indexed account
- High interest on the cash value if the index performs well
- A lock-in on any high rate of return the policy accumulates even if the index goes down at a later time
- Lower premium rate than variable universal life because the cash value account isn’t managed
- Less risky performance than variable universal life because the cash value is not directly invested in the stock market
Cons: Having an FIUL insurance policy can present the following disadvantages.
- Difficulty understanding how the policy works because it’s an advanced type of life insurance
- Not having any interest credited to cash value if the index goes down
- Dealing with more risk than you would with a fixed universal life policy
- Having a cap on the percentage at which the cash value grows if the insurance company sets a maximum limit
Variable Universal Life Pros and Cons
Variable universal life insurance combines the ability to invest your cash value in bonds, stocks, and money market mutual accounts as you would with a variable life policy along with the flexibility features of a universal life policy. Let’s look at some of the universal life insurance pros and cons of this hybrid product.
Pros: You have the opportunity to earn a higher return on interest than with the other types of universal life insurance policies. This means you could build a larger amount of cash value probably in a shorter amount of time.
Cons: This is the most risky of the 3 universal life policy types because your cash value is tied to the performance of managed funds that could decline if the market has a downturn. Having a policy that’s linked to managed accounts also comes with higher premiums. So you could potentially spend a lot of money in premium payments but not get the expected high return on your cash value.
Find a Life Insurance Plan with HealthMarkets
Now that you’ve learned all about the perks and downsides of universal life insurance, you can better decide how this policy could fit your long-term life insurance needs. HealthMarkets can help, at no cost to you. Call (800) 917-4169 to talk to a licensed insurance agent about universal life insurance pros and cons today.