What Is Universal Life Insurance? Explained (2024)

If you’re in the market for a life insurance policy with lifelong coverage, universal life insurance might be the right choice for you. Universal life insurance allows you to tap into the policy’s cash value and will give you the flexibility to adjust your premium payments.

Make sure you’re working with a trusted financial advisor or experienced life insurance agent when considering the best universal life insurance policies. They can be complex.

What Is Universal Life Insurance?

Universal life insurance is a type of permanent life insurance that offers the ability to adjust your premium payment amounts (within certain parameters). Indexed universal life and variable universal life insurance also offer the chance for larger cash value growth.

There are a few types of universal life insurance and it’s important to understand the differences before you purchase a policy.

How Does Universal Life Insurance Work?

Universal life insurance—also known asadjustable life insurance— is distinguished by the ability to adjust your premium payments. This is a valuable feature if your cash flow is variable. You can also adjust your death benefit amount. That means you can lower your death benefit if your need for life insurance decreases over time. Or you may be able to increase your death benefit amount, but you will likely have to go through further underwriting (questions about your health) to get an increase.

Universal life insurance can be in force for the rest of your life (assuming you make the premium payments).

It typically offers a cash value component. You can take money out of cash value via a withdrawal or policy loan. If you surrender a universal life insurance policy, that ends the coverage and you will receive the cash value, minus any surrender charge.

Comparison: Types of Universal Life Insurance

Benefits of Universal Life Insurance

• Can be cheaper than whole life insurance because it doesn’t offer the same guarantees.
• You can vary premium payment amounts and adjust the death benefit amount, within certain limits.
• Universal life insurance policies have a cash value component, although some build minimal cash value.
• If you build up cash value, you can make withdrawals or take out a policy loan from your cash value.

Disadvantages of Universal Life Insurance

• Can be hard to understand because there are different types with very different features.
• Not all universal life insurance guarantees you’ll make gains on cash value.
• Policy loans and withdrawals deplete your cash value and could cause your policy to lapse without extra premium payments.
• Variable universal life insurance needs to be actively managed because of the underlying sub-accounts.

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’ll generally 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 may have little cash value and is typically the cheapest kind of universal life insurance you can buy. You’re paying for the lifelong coverage, not the potential for significant cash value.

GUL is sometimes called “no lapse guarantee universal life insurance.” This is to address recent problems in which 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.

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 little cash value, there won’t be any money to take away. The insurance company will keep the premiums you paid.

Who May Benefit From a Guaranteed Universal Life Insurance Policy?

Guaranteed universal insurance insurance can be a good choice for someone looking primarily for lifelong coverage and who cares less about the “investment” component of cash value. Unlike other types of universal life insurance, a GUL policy doesn’t offer flexibility with the premium payments or death benefit amount.

Average Cost of Guaranteed Universal Life Insurance

Examples of annual rates for a $1 million GUL policy for life insurance buyers who are healthy non-smokers, guaranteed to age 100 or older:

Indexed Universal Life Insurance

Indexed universal life insurance (IUL) offers lifelong coverage and has 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.

The cash value component in IUL is 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. 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.
• There’s usually also a cap on gains, which is the maximum percentage you can gain no matter how well the index performs.

If your index plummets, an IUL policy will 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 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 had invested directly in the index.

Despite its complexity, indexed universal life insurance is a popular product. That may be largely due to advisors steering clients toward these policies.

If you’re considering buying indexed universal life, make sure you understand what you’re buying. The Center for Economic Justice issued a warning in July 2020 that consumers should not buy indexed universal life insurance. The consumer advocacy group cites misleading and deceptive sales practices involving IUL.

“Consumers should avoid IUL because the insurers and agents who sell the product have no obligation to work in the consumer’s best interest. Mix in massively complex products designed to juice illustrations with opaque and unaccountable features and you have the recipe for future financial disaster,” said Birny Birnbaum, director of the Center for Economic Justice, in a statement.

Advisors selling IUL may tout policies based on the rosy pictures painted in policy illustrations. Illustrations often focus on non-guaranteed elements of the policy, such as cash value gains and loans against cash value that look like they won’t cost anything.

But non-guaranteed parts of the policy are just that—projections that might never happen. Policyholders could potentially shell out far more in premiums than they expected to keep a policy in force.

Make sure to examine the guaranteed parts of a policy illustration and ask yourself if you’re OK if that is the reality.

One way to get a better perspective on a policy is to ask your advisor or agent to order a report from Veralytic on the suitability of the product for you. Veralytic is a life insurance analytics firm that measures the qualities of cash value life insurance products and the companies offering them.

Who May Benefit From an Indexed Universal Life Insurance Policy?

Someone who wants flexibility to make changes to a death benefit and premiums and who is OK taking on more investment risks may find an IUL policy appealing.

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 as part of your mix of investments.

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.

Who May Benefit From a Variable Universal Life Insurance Policy?

A person who wants to take an active role in choosing the sub-accounts for the policy’s cash value may be attracted to VUL policies. A variable universal life insurance policy would not be a good choice for a person who wants a passive investment or who is risk averse.

Who Should Consider Universal Life Insurance?

Consider universal life insurance if you’re interested in being able to adjust your premium payment amounts (within limits).

In addition, life insurance buyers who want the potential to grow cash value at more than a small fixed percentage should consider some forms of universal life insurance. Both indexed and variable universal life insurance offer the potential for greater cash value accumulation—if the underlying investments perform well.

Alternative Types of Life Insurance

• 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.
• Whole life insurance. Whole life insurance is generally the most expensive way to buy life insurance because of the guarantees within the policy: Premiums are guaranteed not to change and the cash value has a minimum guaranteed rate of return.
• Term life insurance. Term life insurance offers level premium for a set time period, such as for 5, 10, 15, 20, 25 or 30 years. It doesn’t have a cash value component, and you can’t adjust the premium payments like you can with universal life insurance. But it’s the cheapest way to buy life insurance.

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