In my previous post I explained what term life insurance is and how the insurance carriers calculate your premium. In order to understand universal life insurance, you may want to start by reading my article “What is Term Life Insurance?” The big difference between term life insurance and universal life insurance is that universal life is a permanent policy. Or in other words, its purpose is to provide coverage for your entire life.
It’s important at this point to clarify that Universal Life is not Whole Life Insurance. These are two different types of cash value, permanent policies. In universal life (UL), you’re doing the same thing to calculate the premium as you do in term, but instead of taking an average over just 10 or 20 years, you pay the average price to insure you all the way to age 100. Essentially, UL is term to age 100. In fact, in Canada they have a product called term to 100. So you get your fixed minimum premium, and as long as you pay it, you have coverage for life. The other type of permanent coverage is variable universal life. We don’t have the ability to offer variable universal life insurance quotes on this website.
Difference between Whole Life Insurance and Universal Life
The difference, then, between whole life and UL is that in universal life you have the option only to pay the minimum amount to keep the policy in force, or commonly known as the no-lapse guarantee. With universal life, you have the option of sending more premium, which will in turn build up cash value. Let’s say you just pay the minimum, though, over 15 years, and then you decide to stop paying your premium and move on. Chances are in UL there will be little to nothing by way of cash value surrender. However, in Whole life, and in a sense variable universal life, you really have to overpay in the early years to build up cash value, so that in the later years when the cost of insurance increases, there will be sufficient cash reserves to cover it. But if you leave the policy early, chances are you’ll have some cash value to take with you.
Advantages & Disadvantages of Universal Life Insurance
Now let’s cover the cash value aspect of universal life insurance in more detail, because its flexibility is a big advantage to UL’s. You can think of a UL as a term to age 100 policy with a bank account attached to it (your cash value account). Say your minimum premium is $50 per month. You can send it $50 every month for your whole life and you’ll have your coverage, or you might decide to send in $100. The first $50 goes to paying your insurance costs: cost of insurance, premium fee, administration fee, etc. The other $50 bucks goes into your bank account (cash value account).
The cash value account works similarly to a Roth IRA. It’s not technically a Roth IRA, but it’s something like it. The idea of the cash value acct is to stuff it full of cash and let it accumulate in early years, so you can pay lower premiums or no premiums in later policy years. If you’re 20, you might be thinking, “Look, I don’t want to be paying these premiums when I’m 80 years old.” You don’t have to. What you do is send in additional premium. That additional premium earns interest and grows tax deferred in your cash value account. Eventually, you’ll have enough cash in your policy, that at some point that you can stop making premium payments. The insurance company will then take the cost of insurance out of your cash value, and as long as there are sufficient funds in there, you no longer have to make premium payments.
What some people do is take this overfunding to the extreme, and send in 4-5 times the minimum premium. They do this because of the growth potential and tax advantages of life insurance contracts. I will discuss the investment component of Universal Life Insurance in more depth in a post soon.
There are a few potential disadvantages of universal life insurance. First, I already mentioned it doesn’t build up much cash value unless you overfund it. Second, because it is designed to cover you for life, it is more expensive than term life insurance. Be sure to think about your future need for life insurance, and how long you’ll need it (whether it be to replace income from your job, or to cover a mortgage or SBA loan) before deciding on universal life. You can get term life insurance quotes in the form on the right to compare, and also be sure to read my article on 30 year term life insurance for comparison of plans.
Guaranteed Universal Life Insurance to Age 100
On one last note, be sure your plan is a guaranteed universal life plan, meaning as long as you pay (or your cash value pays) a minimum premium, the death benefit is guaranteed. There are some agents who will illustrate you paying lower premiums, and the policy is projected to stay in force to age 100 as long as the company credits this 4.5% interest rate that they will “definitely do”, or the cash value will build because the policy values are tied to the stock market, as in equity-indexed universal life insurance policies. Don’t count on the market to rise or the insurance company to pay you a certain rate, please. Every universal life illustration will have two columns in the illustration, one for guaranteed values, and one for “assumed values”. I recommend you only look at the guaranteed column. For a universal life insurance quote, simply fill out the instant form on the right side of the page and choose the option guaranteed life insurance “To Age 100 Level Guaranteed.”
{ 2 trackbacks }
{ 1 comment… read it below or add one }
Great article Chris, universal isn’t nearly as popular as term but you are right when you say it’s guaranteed for life and for some people that still matters.