Universal life insurance: What it is & how it works
You can use a universal life insurance policy to create a tax-free legacy for your family or to supplement your retirement income. However, it is best for those who are high earners.
Universal life insurance can be described as a flexible insurance policy with a cash value. You have the option to increase or decrease your premium payments. You can decrease the amount you pay for premiums and it will be taken from the cash value of your policy.
If you are looking for flexibility in your life insurance, a universal policy could work well for you. This policy is best for those who have a high income and are looking to build a nest egg.
The Key Takeaways
- You can apply the cash value of a universal insurance policy to your premiums.
- Universal life insurance is the best option for those who require permanent life insurance or another vehicle to tax-deferred cash accumulation.
- A term life insurance policy with an investment account is the best option for most people.
What is universal life insurance?
Universal life insurance is different from other types of permanent insurance in that you can use your cash value to pay your premiums. It is similar to permanent policies and pays a tax-free funeral benefit to your beneficiaries upon your death.
The death benefit is a portion of the premiums paid. The cash value of your policy earns variable interest but is not subject to tax while it grows.
- Pay your policy premiums
- You can withdraw cash but you will be charged additional fees
- You can take out a loan that you will have to repay with interest
The cash value increases tax-deferred. Withdrawals are subject to income tax
How does universal life insurance work?
Universal life insurance allows for you to adjust your premiums or death benefit according to your needs. You can use the cash value to make payments if you decide to stop paying your premiums or reduce them after a while. You cannot pay the cash value until it has earned enough interest.
Malik S. Lee, Managing Principal at Felton & Peel says that it takes years to start to see the results of your labour and a decent rate of return.
If the policy’s investments are underperforming, you will need to make your premium payments again. Your policy will be cancelled if you have completely depleted your policy’s cash value but still fail to make a premium payment.
Universal life insurance offers permanent coverage so some people choose to use it for their estate planning. You can use the death benefit payout to pay estate taxes.
The cash value of universal life insurance
The market index performance of universal life insurance policies, such as the S&P 500, determines the interest earned. Market fluctuations can also affect the interest earned. The index of your policy depends on the insurer as well as the floor and maximum gains.
“The floor is almost always zero. Patrick Hanzel, a certified financial planner and Advanced Plan Team Leader at Policygenius, says that although the cap for each product is different it is usually between 8 to 13 per cent.
Universal life insurance may not always be the best way to save money for your future. Although you won’t lose any money, you will realize a smaller return if you invest the same amount in an IRA (or 401(k)).
An insurer might set the rate for universal life insurance at 2%. However, the rate for a 401k or IRA that matches historical stock market trends is about 10%.  Term life insurance policies offer a lower rate of return than universal life insurance policies. Financial advisors recommend that you invest the difference and buy term life insurance.
You will also need to keep an eye on your policy annually due to the fluctuating interest rates. If you don’t do so, you could end up paying too much for universal life insurance.
Cost of universal life insurance
Universal life insurance’s actual cost is not fixed at the time you purchase it. This makes it risky financially. Universal life insurance policies are permanent and accrue cash value.
Because of the flexible premiums, it can be hard to set up a budget long-term for this policy. You’ll have to pay a lot for that flexibility before the policy has a cash value.
A universal life insurance policy is expensive and can be difficult to accumulate assets. A licensed life insurance agent can provide a quote for universal life insurance.
The best life insurance options
These are the three best policies that fall under universal life insurance.
- Guaranteed universal insurance: Provides guaranteed death benefits and uniform premium payments throughout the policy’s term.
- Indexed universal insurance: Allows for stock market gains
- Variable universal life insurance: Invest in mutual funds which can increase or decrease cash value.
Indexed universal insurance is the most popular type of life insurance policy that people add to their portfolios. The policy’s cash value is guaranteed to have a minimum and maximum interest rate. This means that if you purchase the policy to increase your investment portfolio, it will not lose money.
Who should purchase universal life insurance?
Universal life insurance products can be purchased for high net-worth individuals who have very specific tax and investment requirements. A universal life insurance policy could be a good addition to your portfolio if you have exhausted all other investment options. A universal life insurance policy can be a great way to build your nest egg, even if you are a high-earner.
First, you need to consider your tax-efficient investments and savings tools. Then, consider your tax-deferred assets. Lee says that you should also look at your taxable accounts, such as your life insurance strategies.
How to get life insurance
An agent at Policygenius can help you find the best policy for you. An agent can help you tailor a universal insurance policy that suits your financial situation to meet your needs.
Is life insurance worth the cost?
Universal life insurance policies are very costly. Most people will opt for a term policy, which offers higher returns and lower costs. A universal life insurance policy may be an option for those who are in high tax brackets. It can also provide tax-deferred asset accumulation that will protect their financial security and that of their loved ones.